* This Supplemental Memorandum Opinion supplements our prior

Memorandum Opinion, InverWorld, Inc. v. Commissioner, T.C. Memo.

1996-301, filed June 27, 1996 (prior opinion).

1 The following cases are consolidated herewith for purposes

of trial, briefing, and opinion: InverWorld, Inc., docket No.

3441-93; InverWorld, Ltd., docket Nos. 27090-90, 3443-93, and

3444-93; and InverWorld Holdings, Inc., docket No. 3442-93. 

T.C. Memo. 1997-226

UNITED STATES TAX COURT

INVERWORLD, INC., ET AL., Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent*

Docket Nos. 27089-90, 27090-90, Filed May 12, 1997.

 3441-93, 3442-93,

 3443-93, 3444-93.1

Turner P. Smith, Nancy E. Delaney, and Robert D. Whoriskey,

for petitioner in docket No. 27089-90.

Turner P. Smith, Nancy E. Delaney, T. Barry Kingham, and

Robert D. Whoriskey, for petitioner in docket No. 27090-90.
- 2 -

2 Unless otherwise indicated, all Rule references are to the

Tax Court Rules of Practice and Procedure, and all section

references are to the Internal Revenue Code in effect for the

years in issue.

3 For INC's taxable years ended June 30, 1987, 1988, and 1989,

INC was joined in the consolidated income tax returns filed by

InverWorld Holdings, Inc. (Holdings), which was the owner of all

of the outstanding stock of INC. Accordingly, respondent's

income allocations to INC pursuant to sec. 482 affect the income

tax liability of Holdings. For convenience and clarity, we make

reference to INC only and include Holdings in such references.

Turner P. Smith and Nancy E. Delaney, for petitioners in

docket Nos. 3441-93, 3442-93, 3443-93, and 3444-93.

Jill Frisch, Peter J. Graziano, and Maria Stabile, for

respondent.

SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION

WELLS, Judge: These cases are before us on petitioners'

motion pursuant to Rule 1612 for reconsideration of our prior

Memorandum Opinion, T.C. Memo. 1996-301 (prior opinion). In our

prior opinion, as to InverWorld, Ltd. (LTD), we held, inter alia,

that LTD was engaged in trade or business within the United

States pursuant to section 864(b), that a certain portion of

LTD's income was effectively connected with the conduct of such

trade or business pursuant to section 864(c), that LTD was liable

for corporate income tax pursuant to section 882(a), and that LTD

was liable for additions to tax pursuant to sections 6651, 6653,

6655, and 6656. As to InverWorld, Inc. (INC),3 we held, inter

alia, that income was to be allocated from LTD to INC pursuant to
- 3 -

section 482, and that INC was liable for additions to tax

pursuant to sections 6651, 6653(a), 6656, and 6661. 

FINDINGS OF FACT

We incorporate into this Opinion by reference the findings

of fact in our prior opinion. Additionally, we restate below

certain of those findings that are relevant to the issues

presented by petitioners' motion for reconsideration. 

Furthermore, we set forth below certain supplementary findings of

fact that were not set forth in our prior opinion but are,

however, based on the record of the trial of the instant case and

relevant to our analysis below. 

Currency Exchange Transactions Income

LTD engaged in two types of currency exchange transactions. 

a. Currency Swaps

LTD arranged for its clients currency swaps, which were

contracts in dollar futures. In a currency swap, LTD and a

client entered into a contract in which LTD agreed to sell U.S.

dollars to the client for Mexican pesos at some future date. The

sale price for the dollars was determined in accordance with the

interest rate negotiated between LTD and the client. LTD's gross

receipts consisted of commissions that it received from Bank of

America and United States Trust for arranging the currency swaps. 

LTD’s direct costs were the commissions it paid out for arranging

the currency swaps. LTD stopped arranging currency swaps on

September 1, 1984. 
- 4 -

The gross receipts and direct costs relating to LTD’s

"Commissions on Foreign Exchange" are as follows:

TYE June 30 Gross Receipts Direct Costs

 1985 $54,386 $24,750

b. Currency Transactions

The second category of currency exchange transactions in

which LTD engaged was the sale and purchase of U.S. dollars on

behalf of clients. LTD maintained a bank account at Frost Bank

in San Antonio that LTD used to collect deposits from clients. 

LTD called the Frost Bank account the "client clearing account"

or "clearing account". LTD engaged in four types of currency

(U.S. dollar-peso) transactions described as follows:

i. LTD arranged sales of U.S. dollars to a client in

exchange for Mexican pesos. The client contacted a promoter in

Mexico, who quoted an exchange rate for pesos to dollars. Once

the client and the promoter agreed on a rate, the promoter

performed the exchange operation from his office in Mexico. The

client made pesos available in Mexico to be exchanged, and the

promoter documented receipt of the pesos. The promoter then

converted the pesos to dollars at a Government-authorized Mexican

exchange house. Once the exchange was executed, the promoter

directed that the dollars be wired to the clearing account in San

Antonio to be credited to the client's account. The transaction

appeared as a credit on the client's monthly statement. LTD
- 5 -

charged the client a fee equal to the difference between the

exchange rate obtained from the Mexican exchange house and the

rate quoted and agreed to by the client. 

ii. LTD sold dollars from its own account to a client in

exchange for pesos. LTD transferred money, usually by wire, from

the clearing account to the client's designated financial

institution. The transaction appeared on LTD's books as a debit

in the clearing account. 

iii. LTD arranged purchases of dollars from a client in

exchange for pesos. LTD verified that the client had sufficient

funds on deposit in its account with LTD. The client then

withdrew dollars from its LTD account to exchange with pesos

obtained by LTD. The transaction appeared as a debit on the

client's monthly statement. 

iv. LTD purchased dollars from a client in exchange for

pesos and deposited the dollars into LTD's own account. The

transaction appeared on LTD's books as a credit to the clearing

account. 

Only transaction type (i) above involved the performance of

personal services in Mexico by a promoter. Specifically, in

transaction type (i), the promoter handled the exchange by

converting pesos to dollars at a Mexican exchange house. In

transactions types (ii), (iii), and (iv), the currency

transactions were handled by INC in San Antonio with pesos being

deposited with or received from Mexican institutions and dollars
- 6 -

being deposited with or withdrawn from U.S. institutions,

including Frost Bank in San Antonio, where the clearing account

was maintained. Additionally, INC maintained records of LTD’s

and its clients’ positions with respect to such currency

transactions. 

LTD ceased to conduct the currency transactions in its own

name as of its taxable year ended June 30, 1989. LTD's currency

transaction income derived from, inter alia, the fees, which were

reflected in the exchange rates, that LTD charged its clients. 

The gross receipts and direct costs relating to LTD’s income from

"Currency Transactions" for each taxable year are as follows:

TYE June 30 Gross Receipts Direct Costs

 1985 1$531,003 - 0 -

 1986 745,001 130,485

 1987 

 2434,867 16,125

 1988 

 3232,426 16,863

1This amount is net of expenses. Neither the revenue

agent's workpapers nor Deloitte's workpapers reveal the gross

receipts.

2The amount of gross receipts includes a check of $11,361

from the Guadalajara office representing its contribution to

profits.

3The amount of gross receipts includes a check of $16,426

from the Guadalajara office representing its contribution to

profits. 

c. Client Incorporation and Trust Creation Fees

LTD offered its clients the option of establishing offshore

corporations and trusts to hold their investments. Each client

signed a discretionary authorization granting LTD the power to

invest the funds held by the client’s corporation or trust. 
- 7 -

To establish an offshore corporation or trust for a client,

a promoter in Mexico completed a form listing the client’s choice

of jurisdiction, and in the case of an offshore corporation, its

name, and the names of those individuals to be appointed

directors. The form was then sent by the promoter to INC, which

passed the information to outside lawyers or fiduciaries

qualified to perform the necessary paperwork in the chosen

jurisdiction. 

The incorporation package completed by the lawyers or

fiduciaries was then returned to INC, which returned the package

to the client in Mexico. LTD's role, through the promoters, was

to provide the counseling on the structure and features of the

various incorporation options. Board of directors' meetings for

at least two companies incorporated by LTD clients were held at

INC’s offices in San Antonio. LTD's clients used as their

address the address of INC’s offices in San Antonio. 

Clients establishing an offshore corporation or trust were

charged fees for the service, which were paid out of their

accounts. LTD charged the clients an "opening expense", which

consisted of LTD's fee and fees for third party lawyers and

fiduciaries, and an "annual expense". LTD’s direct costs were

its payments to the third party lawyers and fiduciaries, document

fees, commissions, and "incorporation expenses". The gross

receipts and direct costs relating to LTD’s "Client Incorporation

Fees" for each taxable year are as follows:
- 8 -

TYE June 30 Gross Receipts Direct Costs

 1986 $147,951 $18,286

 1987 363,014 126,855

 1988 290,518 161,037

 1989 404,286 227,697

OPINION

A. Currency Exchange Transactions Income

In our prior opinion, we found that LTD engaged in two types

of currency exchange transactions: currency swaps, which were

contracts in dollar futures, and currency transactions, which

included the sale and purchase of U.S. dollars on behalf of

clients. We found that LTD engaged in four types of currency

transactions.

Petitioners request that we reconsider our findings that LTD

engaged in currency transaction types (ii) through (iv). 

Petitioners argue that the evidence at trial shows that there was

in fact only one type of currency transaction (type (i)).

Petitioners state that they do not believe there is testimony or

documents to suggest that any of the transaction types (ii)

through (iv) occurred and therefore request that such

transactions be stricken from our findings of fact. 

We found in our prior opinion that, during 1984, LTD and INC

engaged the services of the accounting firm of Deloitte Haskins &

Sells (Deloitte), which performed a separate audit of each

company and a consolidated audit of LTD and subsidiaries for each

taxable year ended June 30, 1984 through 1989. The parties
- 9 -

submitted as joint exhibits workpapers produced by Deloitte in

its audit of LTD and INC, including analysis files, general

files, permanent files, tax service files, Auditors' Reports,

Report Records, draft and Report Copies of Consolidated Financial

Statements, and supporting documents.

In our prior opinion, our findings of fact regarding the

currency transactions were based upon the Deloitte workpapers,

which contained a description of four types of currency

transactions. The Deloitte workpapers were offered and entered

into evidence at trial without any objection by petitioners. 

Consequently, we are satisfied that the record in the instant

case supports our finding that LTD engaged in the four types of

currency transactions described.

Petitioners further request that we reconsider our holding

that, because petitioners did not provide an "apportionment

scheme" for the currency exchange transactions income, all of

LTD's income from currency transactions constitutes income from

sources within the United States. Petitioners contend that none

of LTD's receipts from currency transactions should be deemed

income from sources within the United States because the weight

of the evidence established that INC had only the most marginal

ministerial involvement in any aspect of the currency

transactions. Accordingly, petitioners argue that there is no

need to apportion between INC's role and that of LTD's because

INC's role is immaterial. 
- 10 -

As we see petitioners' arguments, we think that they fail to

appreciate our reference in our prior opinion to an

"apportionment scheme." In our prior opinion, we held that LTD's

income from currency exchange transactions was characterized as

"compensation for personal services performed both in the United

States and outside the United States and is treated as income

from sources partly within and partly without the United States." 

We next stated, "Petitioners, however, did not provide an

apportionment scheme for the currency exchange transactions

income." 

By our reference to an "apportionment scheme", we meant to

address petitioners' failure to establish the extent to which

income items were derived either from services performed inside

the United States, on the one hand, or from services performed

outside the United States, on the other hand. Our reference to

an apportionment scheme was not meant to imply that we were

addressing an apportionment of income items between LTD and INC. 

By that reference, we meant only that petitioners had not set

forth a methodology for ascertaining whether income items were

derived from inside or outside the United States. Based on our

review of the record, we concluded in our prior opinion that two

checks from LTD's Guadalajara office, representing its

contribution to profits, were income items which "derived

directly from the Guadalajara office's currency operations." The

record, however, does not establish that the remaining currency
- 11 -

transactions income (other than the two items of income from the

Guadalajara office) was from sources outside the United States. 

Petitioners bear the burden of proving that the income derived

from sources outside the United States, Rule 142(a), and have not

met that burden. Accordingly, we do not reconsider our holding

that "the remaining currency exchange transactions income is

treated as income from sources within the United States."

Petitioners also argue that the currency exchange

transactions income should not be taxed as effectively connected

income pursuant to section 864(c) because INC's role in the

transactions was only as a bookkeeper, not as "a material factor

in the realization" of LTD's income. Petitioners contend that

the act of contacting institutions for exchange rates is

mistakenly attributed to INC when in fact that was the role of

the promoter in Mexico. 

Contrary to petitioners' argument, we believe that our prior

opinion correctly attributes to INC the act of contacting

institutions for exchange rates. In our prior opinion, we

concluded that the activities of LTD's trade or business relating

to LTD's U.S. source income included "contacting institutions for

exchange rates and depositing or withdrawing dollars or pesos." 

INC was involved in making those contacts on behalf of LTD. As

we stated in our prior opinion, we were addressing the U.S.

source income of both types of currency exchange transactions

that LTD performed: currency swaps and currency transactions. 
- 12 -

LTD's currency swap income consisted of commissions from Bank of

America and United States Trust for arranging the currency swaps,

and LTD paid INC to render services to LTD's clients on behalf of

LTD. At trial, Jose Zollino, treasurer and a director of INC,

testified that, at INC's office in San Antonio, Pablo Cerrilla,

who was in charge of operations for INC, registered "all" of the

foreign exchange transactions, which included currency swaps. 

Additionally, at trial, George Dooley, INC's controller for

approximately 4 years, testified that, at INC's office in San

Antonio, Jose de Abiega worked on foreign exchange transactions,

which included currency swaps. As LTD's currency swap income

consisted of commissions from Bank of America and United States

Trust and as INC handled the currency swaps for LTD's clients, we

are satisfied that the record in the instant case shows that INC

contacted Bank of America and United States Trust to obtain

exchange rates and to arrange the currency swaps. Accordingly,

based on the record, we conclude that the activities of LTD's

trade or business relating to its U.S. source currency exchange

transactions income included, inter alia, contacting institutions

for exchange rates and that INC was engaged in making those

contacts on LTD's behalf.

As to LTD’s U.S. source currency exchange transactions

income, we held in our prior opinion that the activities of LTD's

trade or business were "a material factor in the realization of

the income" within the meaning of section 864(c)(2)(B). 
- 13 -

Petitioners argue in their motion that, because INC’s role in the

currency exchange transactions was "as a bookkeeper only", such

bookkeeping activities do not constitute, as to LTD's trade or

business, "a material factor in the realization of the income"

within the meaning of section 864(c)(2)(B). We do not agree. 

Petitioners do not argue that INC rendered no services with

respect to LTD's currency exchange transactions. Accordingly, we

conclude that petitioners' characterization of INC's activities

as mere bookkeeping does not preclude our holding that, as to

LTD's trade or business, such activities were a material factor

in the realization of the currency exchange transactions income.

In deciding whether the activities of LTD's trade or

business, as carried out on its behalf by INC, were a material

factor in the realization of LTD's currency exchange transactions

income, we consider whether LTD's income was accounted for

through LTD's trade or business under all of the circumstances. 

See sec. 864(c)(2). The activities of LTD's trade or business

relating to the currency swap income included contacting Bank of

America and United States Trust for exchange rates and arranging

the swaps with those institutions. The activities of LTD’s trade

or business relating to the currency transactions income included

effecting the exchange of currencies by depositing or withdrawing

dollars or pesos, and maintaining records of LTD’s and its

clients’ positions with respect to such currency transactions. 

As to such income, we conclude that the activities of LTD's trade
- 14 -

or business were "a material factor in the realization of the

income" within the meaning of section 864(c)(2)(B). 

Consequently, we do not reconsider our holding that LTD's U.S.

source currency exchange transactions income is effectively

connected income pursuant to section 1.864-4(c)(5)(vi)(b), Income

Tax Regs., and section 864(c)(2)(B). 

B. Client Incorporation and Trust Creation Fees

Petitioners request that we reconsider our finding in our

prior opinion regarding the client incorporation fees that "the

incorporation package completed by the lawyers or fiduciaries was

then returned to INC, which returned the package to the client in

Mexico." Petitioners contend that the incorporation packages

were returned not to the client in Mexico but rather to the

promoters, who then dealt directly with their clients. Our

finding was based upon petitioners' proposed finding in their

opening brief, which was supported by the record. The proposed

finding states: "The incorporation package, completed by these

lawyers and fiduciaries, was then returned to San Antonio. From

there, it was forwarded back to the client in Mexico." 

Petitioners' proposed finding of fact makes no mention of

promoters in the process of sending the incorporation package

from INC to the client in Mexico. Accordingly, we do not

reconsider such finding.

Additionally, petitioners request that we reconsider our

holding that LTD's income from client incorporation and trust
- 15 -

4 As we noted in our prior opinion, the record reveals

instances in which LTD dealt with "related" or favored clients

who were charged lower or no fees.

5 The record contains LTD's charges for opening expenses and

annual expenses but does not contain a breakdown of the "opening

expense" between LTD's fee and the fees for third party lawyers

and fiduciaries. As to LTD's expenses, the record either does

not contain a breakdown of incorporation expenses between fees

for third party lawyers and fiduciaries and document fees or does

not establish the nature of the "incorporation expenses".

creation was from sources within the United States. Petitioners

argue that the income was from sources outside the United States

because the promoters provided the counseling, the third party

lawyers and fiduciaries performed the incorporation and trust

creation services, and INC only passed information among the

parties.

For its services of client incorporation and trust creation,

LTD charged its clients:4 (1) an "opening expense", which

consisted of LTD's fee and fees for third party lawyers and

fiduciaries, and (2) an "annual expense". Petitioners did not

offer any evidence establishing the amounts received and paid by

LTD as fees for third party lawyers and fiduciaries. Moreover,

petitioners did not offer a methodology for apportioning or

attributing LTD's income between LTD's fee and the fees for third

party lawyers and fiduciaries. Furthermore, the record does not

provide sufficient information to establish on our own the amount

of income that should be apportioned to each source.5

Petitioners bear the burden of proving that the income derived
- 16 -

from sources outside the United States, Rule 142(a), and have not

met that burden. Accordingly, we do not reconsider our holding

that LTD's income from client incorporation and trust creation is

to be treated as income from sources within the United States. 

C. Pace Investments Income

In our prior opinion, we found that LTD's Pace investments

constituted a specialized mechanism for clients to draw upon

their unused lines of credit with Mexican financial institutions. 

In their motion, however, petitioners ask the Court to reconsider

our finding and to adopt instead petitioners' proposed finding of

fact that "the Pace investment involved merely the purchase of

certificates of deposit issued by the foreign branches of Mexican

banks". 

In our prior opinion, our findings regarding the Pace

investments were based upon the Deloitte workpapers, which

contained a description of the handling of the Pace investments. 

As we stated, supra, the Deloitte workpapers were offered and

entered into evidence at trial without any objection by

petitioners. We are satisfied that the record in the instant

case establishes that the Pace investments constituted a

specialized mechanism for clients to draw upon their unused lines

of credit with Mexican financial institutions. Accordingly, we

do not reconsider such finding. 

Additionally, petitioners argue that, because the Pace

investments interest derived from Mexican banks, the interest
- 17 -

spreads earned by LTD on Pace deposits should constitute income

from sources outside the United States, none of which is

effectively connected to a U.S. trade or business. In our prior

opinion, we held that LTD's Pace investments income "represented

compensation for services rendered in San Antonio in arranging

the Pace investments." As petitioners' argument presumes that

the Pace investments income is interest income, as opposed to

service income that we found it to be, we find that petitioners'

argument has no merit. Accordingly, we do not reconsider our

holding with respect to the Pace investments income. 

D. Section 482 Allocations

In their motion, petitioners ask the Court to reconsider the

section 482 allocations as to four types of income. We note that

LTD paid INC an annual fee for services rendered to LTD. 

Petitioners, however, did not establish the amounts that INC

earned for each individual investment product. Consequently, in

our prior opinion, for purposes of section 482, we compared LTD's

annual payment to INC with the sum of the arm's-length charges

calculated for the services INC rendered to LTD. Turning to

petitioners' motion, we address the first two types of income

together.

1. Currency Fund and FEIM Fund Fees

Petitioners contend that, as to the Currency Fund and the

FEIM Fund, the Court's methodology has the consequence of

allocating to INC amounts which exceed the fees or commissions
- 18 -

that LTD actually received, even on a gross basis, from its

clients. Petitioners argue that the law does not permit

allocation from a parent to a subsidiary of an amount that is

more than the amount that the parent itself actually received. 

Petitioners argue that such an allocation would constitute the

creation, rather than the allocation, of income. Petitioners

also contend that the allocations are inconsistent with our

stated intention to allocate only the "fees that LTD charged its

unrelated clients" because those charges represented the arm'slength charge within the meaning of section 1.482-2(b)(3), Income

Tax Regs. 

Petitioners argue that the maximum allocation to INC should

be the net amount of revenues actually received by LTD for

placing the client funds with third parties. Petitioners contend

that, as respondent's notice of deficiency used a net figure,

viz, LTD's income after direct expenses, in making the original

section 482 allocations, respondent acknowledges that a

allocation of gross receipts is not justified. Alternatively,

petitioners contend that even an allocation of the net amount of

revenues is "excessive", arguing that the evidence shows that INC

did nothing to "manage" the deposits and only made "bookkeeping

entries". As a final alternative argument, petitioners argue

that the FEIM Fund allocation from LTD to INC should be reduced

to zero because of our finding that "INC's only role was to

arrange for transfer of the client funds to Merrill Lynch in
- 19 -

Luxembourg and to include a monthly statement of the client's

allocated share of the fund value". 

We first examine petitioners' argument that the section 482

allocations lead to the "creation" of income. We have previously

held that Smith-Bridgman & Co. v. Commissioner, 16 T.C. 287

(1951), and its progeny, which enunciated the doctrine that

section 482 and its predecessor may not be used to "create"

income, were vitiated by subsequent regulations issued in 1968. 

Latham Park Manor, Inc. v. Commissioner, 69 T.C. 199, 215-216

(1977)(allocating interest income to two subsidiary corporations

that made interest-free loans to their parent corporation, even

though the parent corporation produced no income from the loan

proceeds during the taxable years), affd. without published

opinion 618 F.2d 100 (4th Cir. 1980). Accordingly, petitioners'

reliance on Smith-Bridgman and similar cases is misplaced.

Moreover, we conclude that petitioners' argument that the

inquiry should be limited to the actual amounts of fees or

commissions that LTD itself earned is without merit. In addition

to overcoming respondent's presumption of correctness, under the

law applicable to this case, petitioners have the burden of

proving satisfaction of the arm's-length standard. See Eli Lilly

& Co. v. Commissioner, 856 F.2d 855, 860 (7th Cir. 1988), affg.

in part and revg. in part 84 T.C. 996 (1985); Sundstrand Corp. &

Subs. v. Commissioner, 96 T.C. 226, 354 (1991), affd. 17 F.3d 965

(7th Cir. 1994). If petitioners fail to carry that burden, the
- 20 -

6 Moreover, we conclude that, in any case, the record does not

establish LTD's "actual earnings" as to the Currency Fund and the

FEIM Fund from which to make a comparison. According to the

Deloitte workpapers, management fees as to both the Currency Fund

and the FEIM Fund were charged by LTD against the funds

themselves and were placed in the general category of Management

Fees, not in the individual income categories for the Currency

Fund and the FEIM Fund. After searching the record, we were

unable to ascertain the precise amount of management fees

attributable to the Currency Fund and the FEIM Fund.

Court must determine the proper allocation of items based upon

the record. See Eli Lilly & Co. v. Commissioner, supra;

Sundstrand Corp. & Subs. v. Commissioner, supra. 

Accordingly, our task is to examine whether petitioners met

the arm's-length standard. That standard is met by an arm'slength charge. Secs. 1.482-1(b), 1.482-2(b)(3), Income Tax Regs. 

An arm's-length charge is defined as "the amount which was

charged or would have been charged for the same or similar

services in independent transactions with or between unrelated

parties under similar circumstances considering all relevant

facts." Sec. 1.482-2(b)(3), Income Tax Regs. Significantly, the

regulations do not inquire into or limit the allocation to the

taxpayer's actual earnings. As we found in our prior opinion,

LTD's actual earnings include amounts which were charged to

"related" or favored clients.6 Consequently, as LTD's actual

earnings include amounts that are less than arm's-length charges,

the arm's-length standard found in the section 482 regulations is

not limited by LTD's actual earnings. 
- 21 -

7 As we stated, supra, petitioners did not establish the

amounts that INC earned for each individual investment product. 

Consequently, for purposes of sec. 482, we compare LTD's annual

payment to INC with the sum of the arm's-length charges

calculated for the services INC rendered to LTD.

Our inquiry is whether the fees paid by LTD to INC meet the

standard of arm's-length charges within the meaning of section

1.482-2(b)(3), Income Tax Regs. In our prior opinion, we

concluded that an arm's-length charge, within the meaning of

section 1.482-2(b)(3), Income Tax Regs., for the services

performed by INC on behalf of LTD was the amount that LTD charged

its unrelated clients. Petitioners do not argue that INC

rendered no services relating to the Currency Fund and the FEIM

Fund during the taxable years in issue. After considering

petitioners' arguments, we do not reconsider our holding in our

prior opinion that the arm's-length charges for the services

performed by INC on behalf of LTD are the amounts which LTD

charged its unrelated clients. As the fees that INC reported as

deriving from LTD were less than the arm's-length charges,7

petitioners have not met the arm's-length standard. 

We also find no merit in petitioners' argument that, because

respondent's original section 482 allocations in the notice of

deficiency used net amounts, we may only consider allocations

based upon net amounts. Allocations based upon net amounts are

not dispositive for purposes of the arm's-length framework

provided by section 482 and the regulations thereunder. 
- 22 -

Moreover, we held in our prior opinion that respondent's

allocations are arbitrary insofar as respondent failed to

identify which activities of INC earned what revenue and failed

to distinguish income earned by LTD from income earned by INC. 

Petitioners argue that even an allocation of the net amount

of revenues is "excessive" because INC only made "bookkeeping

entries" and that the FEIM Fund allocation should be reduced to

zero because INC's only role was to arrange for the transfer of

client funds and to include a monthly statement of the client's

share of the fund value. Notwithstanding petitioners'

characterization of INC's services, INC did in fact render

services to LTD related to the Currency Fund and the FEIM Fund. 

INC, as to both funds, inter alia, accepted clients' deposits and

issued periodic statements to clients, and, as to the FEIM Fund,

transferred clients' deposits to Merrill Lynch. As respondent

determined that income should be allocated to INC pursuant to

section 482, INC's true taxable income from its performance of

such services must be ascertained; i.e., the taxable income that

would have resulted to INC in an arm's-length transaction. See

Altama Delta Corp. v. Commissioner, 104 T.C. 424, 456 (1995);

Seagate Tech., Inc. & Consol. Subs. v. Commissioner, 102 T.C.

149, 164 (1994); Sundstrand Corp. & Subs. v. Commissioner, supra

at 353. In our prior opinion, we held that, as to INC's income

derived from rendering services to LTD related to the Currency

Fund and the FEIM Fund, petitioners failed to meet the arm's-
- 23 -

length standard. After considering petitioners' arguments, we do

not reconsider our holdings with respect to the section 482

allocations of income to INC.

2. Currency Exchange Transactions Income

As to the currency exchange transactions income, petitioners

seek reconsideration of the section 482 allocations of LTD's

gross receipts to INC. Petitioners contend that INC's

contribution to the earning of currency exchange revenues was

ministerial at best, as evidenced by the fact that the income was

not a "fee" but rather a "spread". Additionally, petitioners

argue that LTD's promoter in Mexico negotiated the exchange rate

with his client, structured the exchange using a Mexican exchange

house, and calculated and tracked LTD's spread, and, therefore,

there is no basis in the record for our holding that "LTD paid

INC to effect currency transactions". Petitioners argue that

allocating the gross receipts overstates the value of INC's

services to LTD and its promoters in Mexico and gives no credit

to the role and contribution of the promoters. Accordingly,

petitioners argue that the allocation should be based on a charge

in the nature of a fixed, wire transfer fee that would normally

be charged in carrying out the services INC "might be called upon

to perform." We do not agree. 

In our prior opinion, we found that clients paid LTD to

arrange four types of currency transactions. We are satisfied

that the record establishes that the currency transactions were
- 24 -

actually performed, sometimes in combination, by LTD, INC, the

Guadalajara office, and the promoters. As respondent determined

that income should be allocated to INC pursuant to section 482,

INC's true taxable income from its performance of such services

must be ascertained. The record, however, does not establish

that clients made payments to each entity performing a service in

the currency transaction; in other words, clients did not pay a

separate fee to LTD, INC, the Guadalajara office, and the

promoters. 

Nonetheless, in our prior opinion, based upon information

provided in the Deloitte workpapers, we excluded from the section

482 allocations the income earned from services performed by the

Guadalajara office. We, however, did not exclude from the

section 482 allocations any income earned from services performed

by the promoters because petitioners did not provide any basis

for apportioning such income. Additionally, the record did not

provide sufficient information to establish a basis for

apportionment on our own. 

We disagree with the premise of petitioners' argument that

LTD performed only one type of currency transaction for its

clients. As discussed supra and in our prior opinion, LTD

performed four types of currency transactions. Additionally, we

find to be without merit petitioners' argument that INC's

services were "ministerial". Notwithstanding petitioners'

characterization of INC's services, INC did in fact render
- 25 -

services to LTD relating to currency exchange transactions,

including, inter alia, contacting Bank of America and United

States Trust to obtain exchange rates and to arrange the currency

swaps, depositing or withdrawing dollars or pesos, and

maintaining records of LTD's and its clients' positions with

respect to the currency transactions. As respondent determined

that income should be allocated to INC pursuant to section 482,

INC's true taxable income from its performance of such services

must be ascertained; i.e., the taxable income that would have

resulted to INC in an arm's-length transaction. See Altama Delta

Corp. v. Commissioner, supra; Seagate Tech., Inc. & Consol. Subs.

v. Commissioner, supra; Sundstrand Corp. & Subs. v. Commissioner,

supra. 

Petitioners argue that we should "deduct" from the section

482 allocations we made in our prior opinion the income earned

from services performed by the promoters in currency transaction

type (i), in which LTD arranged sales of dollars to a client in

exchange for pesos. As stated above, petitioners argue that an

allocation of the gross receipts to INC gives no credit to the

role and contribution of the promoters. Petitioners suggest a

basis for apportionment in which INC is allocated only a charge

in the nature of a fixed, wire transfer fee that would normally

be charged in carrying out the services INC "might be called upon

to perform." As stated above, we disagree with the premise of

petitioners' argument that LTD performed only one type of
- 26 -

currency transaction for its clients. LTD engaged in four types

of currency transactions. Moreover, petitioners do not point to

any evidence in the record that would support petitioners'

asserted basis for apportionment. Petitioners offered no proof

at trial concerning the transfer fee that would "normally" be

charged under such circumstances. Generally, we do not grant

reconsideration to resolve issues which could have been raised

during the prior proceedings because the parties cannot try their

cases with hindsight. CWT Farms, Inc. v. Commissioner, 79 T.C.

1054, 1057 (1982), affd. 755 F.2d 790 (11th Cir. 1985), and cases

cited therein. Accordingly, as to the currency exchange

transactions income, we do not reconsider our holdings with

respect to the section 482 allocations of income to INC. 

3. Client Incorporation and Trust Creation Fees

Petitioners seek reconsideration of the section 482

allocations of LTD's income from client incorporation fees to

INC. Petitioners argue that the payments to third party lawyers

and fiduciaries are merely repayment of funds LTD advanced to the

contract lawyers or professionals and should therefore be

deducted in the calculation of the arm's-length fee for INC's

services in connection with the client incorporation fees. 

Relying on respondent's original allocations in the notice of

deficiency based on net amounts, petitioners contend that the

section 482 allocations should be reduced by the "direct costs",

which include the payments that LTD made to third party lawyers
- 27 -

8 As we noted supra and in our prior opinion, the record

reveals instances in which LTD dealt with "related" or favored

clients who were charged lower or no fees. 

and fiduciaries. Additionally, petitioners seek to reduce the

client incorporation fees to an amount that petitioners contend

reflects INC's actual contribution to the receipts LTD earned;

i.e., no more than a flat, nominal fee for each incorporation. 

We disagree.

In our prior opinion, we found that clients paid LTD to

establish offshore corporations and trusts to hold their

investments. LTD charged its clients:8 (1) an "opening

expense", which consisted of LTD's fee and fees for third party

lawyers and fiduciaries, and (2) an "annual expense". The record

establishes that the creation of those offshore corporations and

trusts included the performance of services by INC as well as by

third party lawyers and fiduciaries. On behalf of LTD, INC

managed the paperwork for establishing and maintaining the

offshore corporations and trusts while the third party lawyers

and fiduciaries created the offshore corporations and trusts. 

We disagree with petitioners' argument that LTD's payments

to third party lawyers and fiduciaries should be "deducted" from

LTD's gross receipts in deciding the arm's-length fees for INC's

services. An arm's-length charge within the meaning of section

1.482-2(b)(3), Income Tax Regs., is an "amount which was charged

or would have been charged for the same or similar services in
- 28 -

9 As to client incorporations, the record contains LTD's

charges for opening expenses and annual expenses. The record,

however, does not contain LTD's charges for third party lawyers

and fiduciaries or the number of incorporations that LTD

performed for its clients during each taxable year. The record

does contain LTD's charges for opening costs, annual costs, and

lawyers' costs for the creation of client trusts; however, it

does not contain the number of trusts that LTD created for its

clients during each taxable year.

independent transactions with or between unrelated parties under

similar circumstances considering all relevant facts." 

As to INC's services in establishing and maintaining the

offshore corporations and trusts, petitioners did not establish

an arm's-length charge for such services. Petitioners also did

not offer any evidence establishing the amounts received and paid

by LTD for services performed by third party lawyers and

fiduciaries. Moreover, petitioners did not offer a methodology

for apportioning or attributing income between the services

performed by INC and the services performed by the third party

lawyers and fiduciaries. Furthermore, the record does not

provide sufficient information to establish on our own the amount

of income that should be apportioned to each source.9

Consequently, we do not reconsider our holding in our prior

opinion where we allocated income as to the client incorporation

and trust creation fees from LTD to INC.

Finally, we reject petitioners' contention that the client

incorporation fees should be apportioned so that INC receives no

more than a flat, nominal fee for each incorporation. The record
- 29 -

10 As we stated, supra, petitioners did not provide an

apportionment methodology in the first proceeding, and the record

did not provide sufficient information to establish an

apportionment methodology of our own.

11 The amount of LTD's revenues from "Client incorporation and

trust creation fees" during taxable year ended June 30, 1986, on

page 213 of our prior opinion should be changed from $169,263 to

$147,951.

does not contain any evidence of what such a fee might be. 

Moreover, petitioners' apportionment methodology is an argument

which could have been made before the filing of our prior

opinion.10 Generally, we do not grant reconsideration to resolve

issues which could have been raised during the prior proceedings

because the parties cannot try their cases with hindsight. CWT

Farms, Inc. v. Commissioner, supra. Consequently, as to the

client incorporation fees, apart from the correction of a

computational error,11 we do not reconsider our holdings with

respect to the section 482 allocations of income to INC.

On a final note regarding the section 482 allocations, we

are satisfied that, even if LTD were entitled to deduct (1) the

section 482 allocations of income to INC as additional

compensation expenses (we address such correlative adjustments to

LTD's income, infra), (2) its direct costs (except for the

interest amounts in the "Interest Income" category, which have

already been excluded in our prior opinion), and (3) the

compensation expenses for the fees already paid to INC, LTD would

nevertheless have an excess of income over expenses for each of
- 30 -

12 As we found in our prior opinion, during 1986, the

discretionary authorization signed by each LTD client was changed

to include the provision that

The rate of return credited to the Client's account may

not reflect directly the rate of return earned by

specific investments; the Client's rate of return may

be net of expenses or may reflect the fact that * * *

[LTD] may retain the benefit of special rates

attributable to the volume of investments controlled by

* * * [LTD].

13 Section 1.482-1(d)(2), Income Tax Regs., provides:

Whenever the district director makes adjustments

to the income of one member of a group of controlled

taxpayers (such adjustments being referred to in this

(continued...)

the taxable years in issue. As discussed in our prior opinion,

LTD earned income by retaining the difference between the

interest that it obtained on client investments and the interest

that it credited to client accounts,12 which we characterized as

compensation for services. LTD received such service income in

addition to the management fee or commission that it charged its

clients for a particular investment. In sum, we do not

reconsider any of the section 482 allocations of income to INC,

which, as to LTD, take the form of additional compensation

expenses. 

E. Section 482 Correlative Adjustments

Petitioners' motion requests that we reconsider our holding

in our prior opinion that LTD is not entitled to a correlative

adjustment, pursuant to section 1.482-1(d)(2), Income Tax

Regs.,13 once a primary adjustment is made to INC's income. 
- 31 -

13(...continued)

paragraph as "primary" adjustments) he shall also make

appropriate correlative adjustments to the income of

any other member of the group involved in the

allocation. The correlative adjustment shall actually

be made if the United States income tax liability of

the other member would be affected for any pending

taxable year. Thus, if the district director makes an

allocation of income, he shall not only increase the

income of one member of the group, but shall decrease

the income of the other member if such adjustment would

have an effect on the United States income tax

liability of the other member for any pending taxable

year. * * * If a correlative adjustment is not

actually made because it would have no effect on the

United States income tax liability of the other member

involved in the allocation for any pending taxable

year, such adjustment shall nevertheless be deemed to

have been made for the purpose of determining the

United States income tax liability of such member for a

later taxable year, or for the purposes of determining

the United States income tax liability of any person

for any taxable year. The district director shall

furnish to the taxpayer with respect to which the

primary adjustment is made a written statement of the

amount and nature of the correlative adjustment which

is deemed to have been made. 

Petitioners contend that the regulations provide that, if primary

adjustments are made to the income of one member of the group,

correlative adjustments shall be made to the other member "in all

circumstances", subject to the pending year requirement.

Additionally, petitioners argue that the regulations absolutely

mandate that, when the income of one member of the group is

increased, the correlative adjustment "shall actually be made"

and the district director "shall decrease the income of the other

member". Finally, citing Collins Elec. Co. v. Commissioner, 67

T.C. 911, 923-924 (1977), petitioners argue that correlative
- 32 -

14 Section 1.482-1(d)(1), Income Tax Regs., provides:

The method of allocating, apportioning, or

distributing income, deductions, credits, and

allowances to be used by the district director in any

case, including the form of the adjustments and the

character and source of amounts allocated, shall be

determined with reference to the substance of the

particular transactions or arrangements which result in

the avoidance of taxes or the failure to clearly

reflect income. The appropriate adjustments may take

the form of an increase or decrease in gross income,

increase or decrease in deductions (including

depreciation), increase or decrease in basis of assets

(including inventory), or any other adjustment which

(continued...)

adjustments are necessary to avoid multiple taxation of the same

income.

Petitioners' argument that the regulations provide for a

correlative adjustment "in all circumstances" is without merit. 

Section 1.482-1(d)(2), Income Tax Regs., provides that the

district director, whenever making primary adjustments, "shall

also make appropriate correlative adjustments". (Emphasis

added.) We believe that the term "appropriate" serves to limit

the application of a correlative adjustment so that a correlative

adjustment is not made "in all circumstances", but, rather, only

when "appropriate". Sec. 1.482-1(d)(2), Income Tax Regs. 

Additionally, section 1.482-1(d)(1), Income Tax Regs., which

addresses all section 482 adjustments (as opposed to section

1.482-1(d)(2), Income Tax Regs., which addresses only primary and

correlative adjustments), requires that all adjustments be

"appropriate".14 
- 33 -

14(...continued)

may be appropriate under the circumstances. [Emphasis

added.]

In the instant case, for the taxable years in issue, LTD

failed to file timely, true, and accurate returns pursuant to

section 882(c)(2). In our prior opinion, we held that,

consistent with Blenheim Co. v. Commissioner, 125 F.2d 906 (4th

Cir. 1942), and Georday Enters., Ltd. v. Commissioner, 126 F.2d

384 (4th Cir. 1942), LTD is precluded from receiving the benefits

of any deductions that it might have otherwise been entitled to

claim pursuant to section 882(c)(1)(A) had it filed a timely,

true, and accurate return pursuant to section 882(c)(2). See

Espinosa v. Commissioner, 107 T.C. 146 (1996). In the instant

case, the form of the section 482 correlative adjustment to LTD's

income would be an increase in the amount that LTD would be

entitled to deduct pursuant to section 882(c)(1)(A). In our

prior opinion, however, we concluded that, because LTD failed to

file timely, true, and accurate returns pursuant to section

882(c)(2), correlative adjustments to LTD's income, which take

the form of deductions pursuant to section 882(c)(1)(A), were not

appropriate for the taxable years in issue.

In their motion, petitioners elaborate on the argument which

they made on brief regarding the correlative adjustments and

contend that the regulations absolutely mandate that, when the

income of one member of the group is increased, the correlative
- 34 -

adjustment "shall actually be made" and the district director

"shall decrease the income of the other member". We believe that

petitioners' argument fails to appreciate the procedure regarding

correlative adjustments set forth in the regulations. 

Accordingly, we believe that it would be helpful to expand upon

what we stated in our prior opinion. 

Section 1.482-1(d)(2), Income Tax Regs., provides that, in

the event that an appropriate correlative adjustment is made by

the district director, it shall be treated in one of two

alternative ways: The correlative adjustment either (1) shall

actually be made or (2) shall be deemed to have been made. The

proper treatment of a correlative adjustment, if one is made by

the district director, depends on whether or not the U.S. income

tax liability of the "other member" of the group of controlled

taxpayers involved in the allocation (i.e., the taxpayer entitled

to receive an appropriate correlative adjustment) would be

affected for any pending taxable year. 

The regulations provide that, in the event that an

appropriate correlative adjustment is made by the district

director, if the U.S. income tax liability of the other member

would be affected for any pending taxable year, "The correlative

adjustment shall actually be made." Sec. 1.482-1(d)(2), Income

Tax Regs. Alternatively, the regulations provide that, in the

event that an appropriate correlative adjustment is made by the

district director, if the U.S. income tax liability of the other
- 35 -

member would not be affected for any pending taxable year and the

correlative adjustment is therefore not actually made, "such

adjustment shall nevertheless be deemed to have been made" for

purposes of determining the other member's U.S. income tax

liability for a later taxable year or for purposes of determining

any other person's U.S. income tax liability for any taxable

year. Id. 

Accordingly, the regulations provide that an appropriate

correlative adjustment, if one is made by the district director,

either "shall actually be made" or "shall nevertheless be deemed

to have been made". Id. In that context, the phrase, "The

correlative adjustment shall actually be made", is merely a

description of the result that occurs when the district director

makes an appropriate correlative adjustment and the U.S. income

tax liability of the other member would be affected for any

pending taxable year, as opposed to a correlative adjustment that

is deemed to have been made. The phrase "shall actually be

made", therefore, does not mandate that a correlative adjustment

always be made but, rather, serves only to describe one of the

two alternative ways of treating an appropriate correlative

adjustment, if one is made by the district director.

Accordingly, we note that the language, "Thus, if the

district director makes an allocation of income, he shall not

only increase the income of one member of the group, but shall

decrease the income of the other member", appears in the sentence
- 36 -

immediately after the one providing the conditions under which a

correlative adjustment "shall actually be made". In that

context, the language merely describes the steps to be taken when

an appropriate correlative adjustment is "actually" being made. 

Accordingly, we conclude that the phrase "shall decrease the

income of the other member" only applies when the district

director, after deciding that a correlative adjustment is

appropriate under the circumstances, "actually" makes the

correlative adjustment; such language does not mandate that the

district director, when increasing the income of one member of

the group, must always decrease the income of the other member. 

As we held supra and in our prior opinion that LTD is not

entitled to deduct the section 482 allocations of income to INC

as additional compensation expenses because LTD failed to file

timely, true, and accurate returns pursuant to section 882(c)(2),

we conclude that correlative adjustments are not appropriate

under the circumstances of the instant case. 

In our prior opinion, we addressed petitioners' argument

regarding double taxation and distinguished Collins Elec. Co. v.

Commissioner, 67 T.C. 911 (1977). Accordingly, we do not

reconsider our holding that LTD is not entitled to correlative 

adjustments pursuant to section 1.482-1(d)(2), Income Tax Regs.,

for the taxable years in issue.
- 37 -

15 Although not raised by the parties, paragraphs numbered 3

and 4 on page 10, paragraph numbered 3.b. on page 221, and

paragraph numbered 3.c. on page 222 in our prior opinion were

unnecessary because the matters covered by those paragraphs were

covered by the parties in their stipulation and did not require a

decision by the Court. Consequently, in our order to be issued

pursuant to this opinion, we will delete those paragraphs from

our prior opinion.

F. Additions to Tax

In their motion, petitioners elaborate on the arguments

which they made on brief regarding the additions to tax assessed

against INC and Holdings pursuant to sections 6653 and 6661. 

Generally, we do not grant reconsideration to resolve arguments

which could have been raised during the prior proceedings. CWT

Farms, Inc. v. Commissioner, 79 T.C. at 1057. Consequently, we

do not reconsider our holdings in our prior opinion sustaining

respondent's determination of additions to tax for INC and

Holdings pursuant to sections 6653 and 6661. 

We have considered all of the remaining arguments made by

petitioners in their motion and find such arguments to be without

merit.15 To reflect the foregoing,

Appropriate orders

will be issued.