Court Opinion

ID: 4632641
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:12:13.810682+00
Date Added: 2024-06-11T07:57:56.069706
License: Public Domain

Carl Shapiro and Ruth Shapiro, Petitioners, v. Commissioner of Internal Revenue, RespondentShapiro v. CommissionerDocket No. 90671United States Tax Court40 T.C. 34; 1963 U.S. Tax Ct. LEXIS 155; April 12, 1963, Filed *155 Decision to be entered under Rule 50.  Held, T's purported short sale of large amount of Government notes coupled with purported purchase of like amount of Government bonds which he allegedly deposited as collateral for his obligation with respect to the short sale were a sham, and he was not entitled to deductions in respect of bookkeeping entries attempting to establish that he "paid" to the "lender" of the notes the amounts of the interest coupons thereon as they became due.  Sec. 212(1), I.R.C. 1954.  Jack H. Calechman, and John M. Doukas, for the petitioners.Alexander L. Ross, Jr., for the respondent.  Raum, Judge.  RAUM*34  The Commissioner determined a deficiency in petitioners' 1957 income tax in the amount of $ 39,548.40.  That determination raises*156  the question whether interest due on U.S. Government obligations allegedly borrowed from Livingstone & Co. in order to cover a purported short sale was paid to the alleged lender and was deductible by petitioners.  Another question raised by the Commissioner's determination of an increased deficiency in the amount of $ 2,858.83 in an amended answer is no longer in issue.FINDINGS OF FACTThe facts stipulated by the parties and exhibits introduced in evidence are incorporated herein by this reference.*35  The petitioners, husband and wife residing in Newton, Mass., filed their joint Federal income tax return for 1957, on the cash basis, with the district director of internal revenue in Boston.  The husband will hereinafter be referred to as petitioner.Petitioner is a corporate executive.  His compensation from his various corporate enterprises in 1957 was $ 100,000, and the total adjusted goss income reported on his 1957 joint return was $ 142,975.56.  On that return a deduction was claimed in the amount of $ 57,500 as "interest" allegedly paid to Livingstone & Co.  The disallowance of that deduction by the Commissioner presents the principal issue raised by this case, but petitioners*157  now claim the deduction only under section 212(1), I.R.C.1954, as "ordinary and necessary expenses paid * * * (1) for the production or collection of income."Livingstone & Co. is a securities dealer in Boston.  It is a sole proprietorship, owned by M. Eli Livingstone.  His brother, Samuel Livingstone, an attorney, is "house counsel" and officer manager of Livingstone & Co.During the spring of 1956 petitioner and his accountant had a number of conferences with the two Livingstones at the office of Livingstone & Co., with a view to effecting a reduction of his Federal income taxes.  As a consequence of these discussions, petitioner entered into the following preplanned and integrated transactions:On June 18, 1956, petitioner purported to sell $ 2 million principal amount of U.S. Government 2 7/8-percent notes due June 15, 1958, to Salomon Bros. & Hutzler, a securities dealer in New York, hereinafter referred to as Salomon.  The sale was at par plus accrued interest of $ 628.42, resulting in a total purchase price of $ 2,000,628.42; delivery and payment were to be effected the following day, June 19, 1956, at Chemical Corn Exchange Bank in New York.  Petitioner in fact owned no such*158  notes, and the transaction was purportedly to be handled as a "short sale," with Livingstone & Co. lending the notes to petitioner.  It does not appear that Livingstone & Co. owned any such notes, but it theoretically obtained them for this purpose through a purported purchase from Salomon on June 18, 1956, at par plus one-sixty fourth, plus accrued interest, delivery and payment to be made the following day in New York at Chemical Corn Exchange Bank.  1*159 *36   In fact no notes of any kind were delivered at Chemical Corn Exchange Bank on June 19, 1956, or at any other time in consummation of the foregoing "short sale" by petitioner and "purchase" by Livingstone & Co.  The notes involved in the "short sale" by petitioner to Salomon and the notes purportedly purchased by Livingstone & Co. from Salomon to be lent by Livingstone & Co. to petitioner in order to enable him to make the "short sale" to Salomon were merely "paired off." It does not appear that there was any moment of time, even for a split second, when Livingstone & Co. had any control over the notes which it purported to purchase from Salomon and when it could have lent them to petitioner for the purpose of making a short sale or when it was free to deal with them in any other manner.It does not appear that there was any net exchange of funds with Salomon in connection with the foregoing "short sale" by petitioner and "purchase" by Livingstone & Co., other than possibly an amount attributable to the one sixty-fourth premium purportedly paid by Livingstone & Co., which was equal to $ 312.50 in respect of the $ 2 million notes involved.As part of the foregoing transaction*160  petitioner on June 18, 1956, purportedly purchased from Livingstone & Co., $ 2 million face amount U.S. Government 2 3/8-percent bonds due June 15, 1958, with December 15, 1956, and June 15, 1957, coupons detached, at a total purchase price of $ 1,930,000.  Payment was to be made therefor on June 19, 1956, and these bonds were to be deposited as collateral with Livingstone & Co. in connection with the purported loan of the 2 7/8-percent notes.  Livingstone & Co. purportedly obtained the 2 3/8-percent bonds for sale to petitioner by a purchase from Salomon on June 18, 1956, delivery to be made on June 19, 1956, at Chemical Corn Exchange Bank.  No such delivery was in fact made.  Instead, Livingstone & Co. made a "short sale" of these bonds on June 18, 1956, to Samuel Livingstone, who in turn purported to make a sale thereof on June 18, 1956, to Salomon, delivery and payment to be effected at Chemical Corn Exchange Bank in New York on June 19, 1956.  As in the case of the 2 7/8-percent notes, these 2 3/8-percent bonds were "paired off" against the bonds which Livingstone & Co. purportedly purchased from Salomon, and no such bonds ever left the vaults of Salomon nor were any such bonds*161  transferred to or from Salomon in any other way.Thus, as of the close of June 19, 1956, none of the 2 7/8-percent notes and none of the 2 3/8-percent bonds purportedly involved in these transactions had passed from Salomon, nor was Salomon under any obligation thereafter to transfer any such notes or bonds to any of the parties referred to above.  Nevertheless, as between petitioner and Livingstone & Co. it was made to appear that petitioner had made *37  a short sale of $ 2 million notes (2 7/8 percent) which Livingstone & Co. had lent to him, and that he had purchased $ 2 million bonds (2 3/8 percent) from Livingstone & Co. which the latter obtained from Salomon and which petitioner had put up as collateral with Livingstone & Co. in connection with the loan of the notes.Since there was theoretically $ 2,000,628.42 due to petitioner as the proceeds of his "short sale" of the 2 7/8-percent notes and since he theoretically owed $ 1,930,000 on his purchase of the 2 3/8-percent bonds, there appeared a balance of $ 70,628.42 in petitioner's favor on the books of Livingstone & Co.  It was out of this balance, as subsequently augmented in the manner hereinafter set forth, that petitioner*162  made the "payments" to Livingstone & Co. which he originally claimed as interest deductions and which he now claims were ordinary and necessary expenses paid for the production or collection of income.On December 15, 1956, Livingstone & Co. charged petitioner's $ 70,628.42 balance with $ 28,750, the amount of the December 15, 1956, interest coupons on the 2 7/8-percent notes which petitioner had purportedly borrowed from Livingstone & Co. and which he had not yet returned.  Petitioner's deduction of that $ 28,750 on his 1956 return is not involved in this proceeding.The balance in petitioner's favor on the books of Livingstone & Co., after the foregoing debit, was $ 41,878.42.  Thereafter, in 1957, Livingstone & Co. again undertook to charge petitioner's balance with $ 28,750 on June 15 and December 15, the amount of the interest coupons on the allegedly borrowed 2 7/8-percent notes.  At the same time, on December 15, 1957, Livingstone & Co. credited petitioner's balance with $ 23,750, the amount of the December 15, 1957, interest coupons on the 2 3/8-percent bonds purportedly owned by petitioner which had theoretically been put up with Livingstone & Co. as collateral. As a consequence*163  of the foregoing two debits of $ 28,750 each and the credit of $ 23,750, the credit balance in petitioner's favor appeared as $ 8,128.42, as of the end of 1957.On petitioner's 1957 joint return, a deduction was taken for interest allegedly paid to Livingstone & Co. in the amount of $ 57,500, being the sum of the two $ 28,750 debits referred to in the preceding paragraph.  In that return petitioner also reported the $ 23,750 credit as income.On May 14, 1958, petitioner purported to sell his 2 3/8-percent bonds to Livingstone Securities Corp. at a total price (including accrued interest) of $ 2,025,199.18, and on the same day he purported to buy back the same bonds from Livingstone Securities Corp. at a total price (including accrued interest) of $ 2,025,824.18.  These sales and repurchase prices appear as a credit and debit, respectively, on petitioner's account with Livingstone & Co.  Petitioner in fact had no *38  such bonds to sell on May 14, 1958; he in fact made no such sale; and he in fact made no such purchase or repurchase on that day.  In his 1958 return, however, he reported as capital gain the excess of the alleged sales price over his purported basis in such bonds. *164  As of June 15, 1958, the maturity date of the 2 7/8-percent notes and the 2 3/8-percent bonds, petitioner's account with Livingstone & Co. was debited with $ 28,750 (the amount of the June 15, 1958, interest coupons theoretically applicable to the $ 2 million 2 7/8-percent notes) and credited with $ 23,750 (the amount of the June 15, 1958, interest coupons theoretically applicable to the $ 2 million 2 3/8-percent bonds).  Upon winding up of the account, accomplished by various bookkeeping entries involving Livingstone Securities Corp., there appeared a balance of $ 1,903.42 in petitioner's favor on June 16, 1958.At the time that petitioner entered into the foregoing transactions with Livingstone & Co. in 1956, he agreed to pay a "premium" of $ 16,600 for the "loan" of the $ 2 million 2 7/8-percent notes.  That agreement was contained in a letter dated June 19, 1956, to Livingstone & Co., in which petitioner "[acknowledged] receipt" of such notes.  He in fact never received any such notes.  The $ 16,600 "premium" was payable, $ 16,000 in advance and the balance of $ 600 when the "securities borrowed are returned." Petitioner in fact paid the $ 16,000 to Livingstone & Co. on June 22, *165  1956, and the remaining $ 600 was reflected in the final balance of $ 1,903.42 in petitioner's favor on the books of Livingstone & Co. as of June 16, 1958.  Livingstone & Co. paid petitioner that $ 1,903.42.  Thus, the only funds actually paid out by petitioner in connection with all of the transactions set forth in these findings consisted of the foregoing "premium" of $ 16,000, as reduced by the $ 1,903.42 balance.  Such "premium" was not in fact paid for the "loan" of any securities, but was simply a fee for arranging the foregoing paper transactions with the expectation that they would result in net tax advantages for petitioner.The amounts in controversy, claimed as deductions in 1957, were neither interest nor ordinary and necessary expenses paid for the production or collection of income.OPINIONPetitioner's claim to the $ 57,500 deduction in 1957 rests upon the well-established rule that one who borrows securities in order to make a short sale may deduct interest or dividends payable with respect to such securities during the period of the loan where the borrower in fact pays such amounts to the lender. I.T. 3989, 1 C.B. 34">1950-1 C.B. 34. That rule, however, *166  is inapplicable here because petitioner has failed to show that there was in fact any such bona fide short sale *39  or that he in fact made any such payments to the purported lender, Livingstone & Co.The burden of proof is, of course, upon the petitioner, and if there should be a gap in the record, it may not be presumed that any missing facts are favorable to him.  But we need not rely here upon any failure of proof, for the record strongly shows that there was no bona fide short sale by petitioner and that the complex interrelated transactions that he purportedly entered into were nothing more than an elaborate sham. There were in fact no purchases, short sales, or other transactions relating to the large blocks of Government obligations purportedly involved herein.  The various matching buy and sell orders and the meticulously detailed bookkeeping entries merely gave a misleading appearance of reality to that which in fact did not exist.  Petitioner's position is utterly without merit.  Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affirmed 267 F. 2d 127 (C.A. 1); Broome v. United States, 170 F. Supp. 613*167  (Ct. Cl.); Sonnabend v. Commissioner, 267 F. 2d 319 (C.A. 1), affirming per curiam a Memorandum Opinion of this Court; Lynch v. Commissioner, 273 F. 2d 867 (C.A. 2), affirming 31 T.C. 990">31 T.C. 990 and Leslie Julian, 31 T.C. 998">31 T.C. 998; Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001; Becker v. Commissioner, 277 F. 2d 146 (C.A. 2), affirming a Memorandum Opinion of this Court; Morris R. DeWoskin, 35 T.C. 356">35 T.C. 356, appeal dismissed (C.A. 7); Perry A. Nichols, 37 T.C. 772">37 T.C. 772, affirmed 314 F. 2d 337 (C.A. 5); Empire Press, Inc., 35 T.C. 136">35 T.C. 136. Cf.  Knetsch v. United States, 364 U.S. 361">364 U.S. 361; Amor F. Pierce, 37 T.C. 1039">37 T.C. 1039, affirmed 311 F. 2d 894 (C.A. 9); A. A. Helwig, 37 T.C. 1046">37 T.C. 1046; United States v. Roderick, 290 F. 2d 823 (C.A. 5); MacRae v. Commissioner, 294 F. 2d 56*168  (C.A. 9), affirming in part and remanding in part 34 T.C. 20">34 T.C. 20, certiorari denied 368 U.S. 955">368 U.S. 955; Kaye v. Commissioner, 287 F. 2d 40 (C.A. 9), affirming per curiam 33 T.C. 511">33 T.C. 511; Weller v. Commissioner, 294">270 F. 2d 294 (C.A. 3), affirming 31 T.C. 33">31 T.C. 33 and W. Stuart Emmons, 31 T.C. 26">31 T.C. 26, certiorari denied 364 U.S. 908">364 U.S. 908; William R. Lovett, 37 T.C. 317">37 T.C. 317.The deduction sought by petitioner does not qualify under section 212(1) of the 1954 code as "ordinary and necessary expenses paid * * * (1) for the production or collection of income." Not only were no such expenses in fact "paid" by reason of the sham character of the transactions, but in any event they were not related to the "production or collection" of income.  Notwithstanding some euphemistically phrased testimony by petitioner we do not believe that he ever expected to make any profit out of these transactions.  It is all too clear to us that he contemplated merely a net expenditure*169  of funds (somewhat under $ 16,000) as a fee to Livingstone & Co. for which he hoped to obtain net tax advantages that were substantially in excess of that fee.  But the avoidance of taxes hardly qualifies as "the production or *40  collection of income" under the statute, either literally or by any implication that is supported by any relevant legislative history.Our conclusion is in accord with two recent memorandum opinions involving factual situations closely parallel to the present case.  James A. Dooley and Virginia P. Dooley, T.C. Memo. 1962-305; Louis H. Lewis and Annette Lewis, T.C. Memo 1962-306">T.C. Memo. 1962-306.Petitioners raise an alternative issue that if the disallowance of the $ 57,500 deduction is approved they are entitled to exclude from income the $ 23,750 interest which they reported in respect of the 2 3/8-percent bonds in 1957.  The Commissioner has not dealt with this matter in his brief, and we assume that the parties will agree upon the proper treatment of this item under theDecision to be entered under Rule 50.  Footnotes1. Livingstone & Co.'s purported purchase from Salomon was in the face amount of $ 3 million of such notes, $ 2 million being allocable to petitioner, and $ 1 million to a person named Gordon in a parallel transaction.  The parties herein have treated such purchase as pertaining proportionately to petitioner, and, for convenience, the findings hereinafter will refer merely to the proportionate amount referable to petitioner rather than to the combined amounts, not only as to these 2 7/8-percent notes but also to a like amount of 2 3/8-percent bonds hereinafter described which Livingstone & Co. likewise purported to purchase in connection with petitioner's and Gordon's transactions.↩