Opinion ID: 489588
Heading Depth: 2
Heading Rank: 3

Heading: Constructive Dividend Treatment of Interest and Palomate Profit

Text: 32 We review the Tax Court's determination that GFS' retention of interest and Palomate's retention of profits constitute constructive dividends to Ricchiuti for clear error. Akland v. Commissioner, 767 F.2d 618, 620 (9th Cir.1985). Corporate expenditures constitute constructive dividends only if 1) the expenditures do not give rise to a deduction on behalf of the corporation, and 2) the expenditures create economic gain, benefit, or income to the owner-taxpayer. Meridian Wood Products Co. v. United States, 725 F.2d 1183, 1191 (9th Cir.1984), citing Palo Alto Town & Country Village Inc., v. Commissioner, 565 F.2d 1388, 1391 (9th Cir.1977). 33 We have already held that Palomate served no real economic function in storage and marketing of P.R. Farms' fruit. Any benefit conferred upon Palomate by P.R. Farms in connection with fruit sales was gratuitous. Accordingly, P.R. Farms may not deduct profits from fruit sales retained by Palomate as ordinary and necessary business expenses. 34 Palomate's retention of profit from sales of fruit allegedly purchased from P.R. Farms benefited Ricchiuti's children. Transfer of income within the family presumably benefits both transferor and transferee. See Helvering v. Clifford, 309 U.S. 331, 335, 60 S.Ct. 554, 556, 84 L.Ed. 788 (1940). The Tax Court's determination that Ricchiuti received constructive dividends in the amount of Palomate's profit on fruit sales was not clearly erroneous. 35 Because P.R. Farms was not legally obligated to allow GFS to retain and invest proceeds from sale of P.R. Farms fruit, P.R. Farms may not deduct interest retained by GFS as an ordinary and necessary business expense. 36 Allowing GFS to retain interest earned on certificates of deposit purchased with P.R. Farms' income increased GFS' net worth. As 50% shareholder in GFS, Ricchiuti benefited from GFS' retention of interest income. Ricchiuti would not have realized as great a benefit if 1) GFS remitted sales proceeds to P.R. Farms immediately, 2) P.R. Farms invested in certificates of deposit, 3) P.R. Farms paid Ricchiuti dividends equal to the after tax amount of interest earned, and 4) Ricchiuti contributed what remained of the interest to GFS. 37 Our examination of the record convinces us that Ricchiuti had authority to structure transactions in the forgoing manner had he so desired. Had interest earned on certificates of deposit been taxed according to the economic reality, the interest would be taxed twice before it reached GFS--once to P.R. Farms as return on investment and once to Ricchiuti as dividend income. By allowing GFS to retain interest earned on sales proceeds, the interest income was not taxed to either GFS or Ricchiuti during the audit period. 1 P.R. Farms' expenditure in allowing GFS to retain interest earned on certificates of deposit inured to Ricchiuti's benefit. The Tax Court's determination that interest retained by GFS constituted a constructive dividend to Ricchiuti was not clearly erroneous. 38 The judgment of the Tax Court is AFFIRMED.