T .C . Memo . 2009-22 7

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T .C . Memo . 2009-22 7

11

UNITED STATES TAX COUR T

ESTATE OF CLOYD F . ANGLE, DECEASED, BONNIE J . ANGLE, SPECIAL

ADMINISTRATOR, AND BONNIE J . ANGLE, Petitioners Y .

COMMISSIONER OF INTERNAL REVENUE, Responden t

Docket No . 13718-01 .

Howard Fisher ,

Filed

Diana Callaghan ,

October

5,

20'09 .

David Lee Rice , and

John A .

Harbin , for petitioners (at trial) .

Michael W . Berwind and Steven M . Roth , for respondent .

MEMORANDUM FINDINGS OF FACT AND OPINIO N

HOLMES,

Judge : Cloyd Angle began 1995 as the owner of

98

shares (or 49 percent) of Cal-Almond, Inc ., a prosperouslfamilyowned business . By the end of 1995, Cal-Almond had sold all of

its assets at a considerable gain . Cloyd .reported no gain ,

ED OCT - 5 .2000

2 however, on the Angles' 1995 return .' He claimed to have

exchanged his shares, via an expensive and convoluted . rerouting

through several Caribbean trusts and corporations, into two

private and (in 1995, at least) nontaxable annuities . We must

determine if his .position was justified .

FINDINGS OF FAC T

The almond industry is big business in California . In the

mid-1990s, the valleys of central and southern California

produced 68 percent (or 245,000 tons) of all the almonds in the

world,2 and Cal-Almond processed approximately 25,000 of those

tons . That made Cal-Almond one of the top four almond processors

in the country .

Cloyd had incorporated Cal-Almond in 1979, but by 1990 he

had ceded most day-to-day control to his son Tyler . Tyler Angle,

had . by then concluded that his father was no longer focused on

the business . He told Cloyd that he wanted to take over, and

Cloyd agreed . Tyler started buying shares of Cal-Almond stock

and brought in Bob Nunes as Cal-Almond's new CFO . The two

younger men took over the day-to-day responsibilities of runnin g

the company . By the end of 1994, Tyler owned 51 percent of th e

' Cloyd's wife Bonnie is a party only because she and Cloyd

filed a joint return, and because she is the special

administrator of his estate .

2 Food and Agriculture Organization of the United Nations,

Inventory of Almond Research, Germplasm and References (1997),

available at http ://www .fao .org/docrep/X5337E/x5337e02 .htm .

_ 3 company and had more than tripled the volume of almonds

processed, while Cloyd's participation withered to little more .

than reviewing the firm's financial reports .

Cloyd wanted out--but only if he could get enough money . ,

Tyler himself offered Cloyd $10 million, which would-have bee n

enough if Tyler had shelled it out all at once . But Tyler-wanted

to stretch the payments over 10 years, and Cloyd

About this same

eying Cal-Almond .

refused . ]

time, a company called Morven Partners-began

Morven was a jumbo-sized presence in tk e

nutmeat industry, but had not dipped very far into almonds .

Cloyd did not at first tell Tyler about'Morven's interests

instead, he . confided in Nunes that he was going,to "get rid o f

them" by "throw[ing] out a number that they wouldn't . accept ."

That number .was $20 million ; Morven didn't balk . They even tol d

Cloyd that they would pay the .$ 20 million for the whole business .

That was enough for Cloyd .

He told Tyler about the offer and

soon convinced Tyler that they both should sell .

In-Octobe r

1994, Morven signed a letter of intent to buy Cal-Almond, ;which

allowed Morven .to begin due diligenceon the firm's operations .

Cloyd's only concern about-selling the company was that h e

would have to pay taxes on whatever hereceived .3 But then h e

spotted an advertisement for books and tapes on offshore ta x

3 In his notice of deficiency, the Commissioner assumed that

Cloyd's basis in his stock was zero and there is nothing in the

record to contradict that assumption .

Lawrence Heller . Heller was an international-tax attorney in Los

Angeles whb .had practice working with private annuities . He was

also a partner in Whitman Breed Abbott and Morgan, a full-service

law firm which could--and later did--provide assistance with the

Cal-Almond sale to Morven . From Schneider and Norman's

`

perspective, it was a perfect fit--especially because they knew

that Heller's close relationship with Norman would help nudge him

to go along with whatever annuity terms Cloyd required .

With Heller in place,

Schneider and Norman next set t o

finding a company to "find" the offshore group that Heller woul d

be-representing . Schneider owned a brokerage firm,

AmeriNational, which was on the verge of insolvency and needed

cash . At Norman's"suggestion, they decided to use AmeriNational

to play the role of finder, with Heller and Whitman Breed acting

as AmeriNational's attorneys . Heller drew up an engagement

letter addressed to AmeriNational's president, . Peter Provence ,

discussing this .representation .- According to 'Provenc e

--and we specifically find him credible on this point--not only

did that letter never make it to his desk, but he himself never

even heard of Heller or Whitman Breed before preparing to testify

in this case . Provence also testified credibly that

AmeriNational never paid the $25,000 retainer that the letter

claimed it had, claiming that such a large amount "would have put

- 7 * * * [AmeriNational] in a net capital

violation and it woul d

have stopped--shut down the firm that day . "

Provence did sign a few documents which were connected with

the Angles' transaction, but he did so without reading the m

because Schneider told Provence to just sign whatever documents

Heller put in front of him . We therefore find that Schneide r

controlled everything to do with the Angles' deal and used

Provence only to lend an air of legitimacy to AmeriNational's .

involvement--which was ultimately just to act as a clearinghouse

through which the various attorneys and corporations billed thei r

services . As charges were incurred . for the Angles' transaction ,

invoices were sent to AmeriNational or to Schneider's othe r

corporation, Wilshire Trust . Those invoices were then forwarde d

to Cal-Almond for Cloyd's approval . Once Cloyd approved the

payment, he sent money to Wilshire Trust for disbursement ; ther e

is no evidence that AmeriNational itself ever paid any of,the

invoices it received .

We therefore find that AmeriNational never provided an y

services for the Angles other than receiving and forwardin g

invoices, despite a paper trail that features a Transaction

Facilitation Agreement, which Heller also drafted, between

AmeriNational and the Angles . This Agreement promise d

AmeriNational would advise Cloyd and Tyler on how to dispose of ,

their Cal-Almond stock and introduce them to financial

8

_

intermediaries who could assist in the disposal . Provence

credibly testified, however, that AmeriNational didn't hav e

anybody at the firm experienced in investment banking, nor di d

AmeriNational provide any of the supposed services outlined in

the Agreement . Even if AmeriNational had the expertise, it would

have had no time to perform--the Agreement was drafted on May 4,

1995, just days before Cloyd signed a Stock Purchase Agreement to

sell his Cal-Almond stock . The Transaction Facilitation

Agreement was backdated with an effective date of January 13,

1995, to make it appear as if AmeriNational had been involved

from the beginning, but we find this all to be just another part

of Schneider's fictitious paper trail, laid down to make the deal

look legitmate .

Meanwhile, in January 1995, Cloyd and Bonnie began working

on another part of the Schneider/Norman/Heller plan--expatriation

to 'a Caribbean country with low or no income tax .' Their trip to

the Caribbean also enabled Cloyd to visit the British Virgin

Islands along with Schneider, Norman, and Heller . The four met

there with a representative of TrustNet Group, a BVI trust

company, who provided them with a list of approximately 30 "off-

' The expatriation part of the plan didn't work out . Cloyd

and Bonnie became citizens of St . Kitts and Nevis on January 18,

1995, but they didn't have a consul prepare Certificates of Loss

of Nationality of the United States until March 14, 1996, and

those certificates weren't approved until August 8, 1996 . The

Angles conceded before trial that for income-tax purposes they

were U .S . residents throughout 1995 .

I

- 9 the-shelf" corporations .6 Cloyd looked over the list and decided

that he would buy Molseberry, Ltd . (Molseberry), and Padang

Securities, Ltd . (Padang), as the corporations . to which he would

sell his Cal-Almond stock, not because they had any assets or

because he'd actually performed due diligence on them--which he .

hadn't--but because he liked the names .

In April 1995, the final offshore structure was set .'

Molseberry issued all of its stock to Padang, which then issued

its stock to three different entities : Investment Capital

Corporations (ICC), a Turks and Caicos-based company created

solely for this transaction by The Chartered Trust Co ., Ltd . ; ATC

Trustees, Ltd . (ATC), a BVI-based affiliate of a Dutch company,

ATC Group ; and Padang Securities Limited Purpose Trust (Padan g

Trust), which was created as a BVI trust sometime before April

1995, and whose BVI trustee was Codan Trustees, Ltd . (Codan) .

ICC and . ATC were each paid $10,000 to take 45 percent of Padang's

stock ; and Codan was promised an annual $3,000 retainer to tak e

10 percent of Padang's stock as trustee of Padang Trust, and to

provide trustee and director services . HWR Trustees, a BVI-base d

6 Such corporations are companies that have been

incorporated but not yet used for any business purpose .

I

' Tyler set up an almost identical structure to thatfof his

father . The only difference is that he used a corporation named

Bergston, Ltd ., in place of Molseberry ; Padang owned both'of

these corporations, so the entire structure beyond Padang is the

same .

10

company, was named the enforcer for Padang Trust, which meant it

had the power to hire and fire the trustee . We specifically find

that grafting these entities to each other was intended by all

involved to camouflage Cloyd and Tyler from the trust that was to

hold their Cal-Almond . money . But, as we shall see, Cloyd

remained in control .

When all this artificial foliage was finally arranged, it

looked like this :

HWR

Trustee s

(BVI)

Codan Trustees,

Ltd .

(BVI )

T

Enforcer

Trust Co .

(T&C )

Investment

Capital Corps .

(T&C)

Padang

Securities ,

Ltd .

(BVI)

100%

Molseberry,

Ltd .

BVI

100 %

Bergston, Ltd .

(BVI)

- 1 .1 On May 9, 1995, Molseberry and Cloyd entered into the Stock

Purchase Agreement . Cloyd agreed to "sell" his 98 shares°of CalAlmond stock in exchange for two unsecured private annuities,

with the payment schedule to be determined later . This Agreemen t

was "negotiated"--at least on paper, though we find that ther e

was nothing more than an appearance of negotiation--betwee n

Norman and Heller . The closing, at which Cloyd was to turn ove r

his shares of stock, was scheduled to take place in the BVI on

May 12,

1995 .

Cloyd, however, did not deliver the stock to

Molseberry until October 25, 1995 . Molseberry did not seek any

damages for this significant delay in performance .

Sometime between May 9 and October 25, 1995, Tyler met wit h

Morven and informed it of the upcoming change in Cal-Almond' s

ownership . Tyler explained (and we specifically find) that thi s

change was being, made only so that Cloyd and Tyler could manag e

the tax consequences of the sale . There was never any indicatio n

that Morven would actually be dealing with anyone new, and Tyle r

remained Morven's point of contact throughout the sale process .

As long as the new shareholders were authorized to sell CalAlmond' s . assets --and willing to do so--Morven really didn't care .

It continued its due diligence of Cal-Almond as if nothing ha d

changed .

No other significant events occurred until October 25, 1995,

when Molseberry'finally received the Cal-Almond shares from Cloyd

12 and supposedly executed two private annuities in Cloyd's favor .

The first of these annuities had an effective date of October 25,

1995, and'an annuity start date of March 1, 1996 ; the second had

an effective date of January 1, 1996, and an annuity start date

of July 1, 1997 . The exact payout schedule was not included in

the record for either of the annuities, but the bulk of the

payout was to be paid in the first five years with token payments

continuing after that for the duration of Cloyd's life expectancy

according to the IRS charts . 8

On October 26, 2005, Padang guaranteed Molseberry's annuity

commitments and the Padang shareholders agreed to restrictions on

their ability to sell Padang stock . There is nothing in th e

record, however, to suggest that Padang actually owned any

assets--other than Molseberry itself--to back this guaranty .

It's impossible even to conclude that Padang's"owners" were in

any way investing for their own account . Padang's articles o f

association forbade it from taking a dividend out of Molseberry,

and the shareholders' agreement forbade them from selling or

borrowing against the shares . The only realistic source of

profit for them was to charge fees--and the record shows tha t

8 To compute the required minimum annual distribution of an

annuity, one divides the annuitant's account balance by the

.applicable distribution period (or life expectancy) . The IRS

publishes tables of life expectancies which private parties can

use . See Internal Revenue Service, Publication 590, Individual

Retirement Arrangements (IRAs) .

- 13 Cal-Almond (on Cloyd's approval) continued to pay hefty fees for

months after Cal-Almond',s stock was owned by Molseberry .

;Even a s

late as 1998, one of Padang's paper shareholders, ATC, complaine d

to one of Cloyd' s Canadian lawyers that it felt itself entitle d

to continuing annual payments for its part in the deal .

We therefore find that Cloyd effectively controlled both

Molseberry and Padang ,

and therefore controlled how and when th e

stock would be sold . The restrictions to which Padang's suppose d

owners agreed were really just more leaves along the paper, trai l

which Schneider, Norman, and Heller were still blazing . .

Back in the real world, Morven signed an Asset Purchas e

Agreement in the first week of November 1995 in which Cal-Almond

sold'its assets to Morven and received $20 million cash in

exchange . After the sale, Cal-Almond began a process of

liquidation and opened up a new account called the Cal-Almond

Shareholders Trust, into which it placed the cash from Morven .

The Shareholders Trust account was managed,by the Cal-Almond

board of directors, which meant that it was actually managed by

Cloyd and Tyler ; none of the Caribbean paper shareholders had any

representation in Cal-Almond at any time .

Cloyd and Tyler kept all of the proceeds in the Shareholders

Trust for approximately six months while .Molseberry attempted to

set up Molseberry Limited Investment Trust (Molseberry Trust),

the trust which was--at least on paper--to administer Cloyd's

- 14

private annuity . Norman and Heller wanted Molseberry Trust in

place before any cash was transferred out of Cal-Almond so that

the money would be going into a trust instead of a corporation .

However, Cloyd grew impatient and ordered the money to be wired

to Molseberry in May 1996 before Molseberry Trust was formed .

The record is unclear on what happened to the money after it

was wired to Molseberry . Cloyd and Bonnie became Canadian

residents in late 1995, and at least $3 .2 million was transferred

at Cloyd's direction to Canadian Agriculture--a Cayman Islands

corporation through which Cloyd hoped to distribute his money

into Canada tax free .- (At the time, Canada had a law under whose

terms new immigrants could receive foreign trust income tax free

for their first five years of residence, as long as they didn't

retain control of the trust . Cloyd planned to use a .five-year

trust through Canadian Agriculture and earn income on the $3 .2

million tax free--he didn't want to avoid taxes in the United

States only to then have to pay them to Canada . )

The Commissioner sent a notice of deficiency to Cloyd and

Bonnie for their 1995 tax year . The notice included the full

amount of the Cal-Almond sale in their taxable, income, and showed .

a tax due of more than $2 million plus a 20-percent penalty under

section 6662 for substantially understating their income tax . '

9 Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the years at issue and al l

(continued . . .)

15 Cloyd and Bonnie were residing in British Columbia, Canada, when

they filed a timely petition to contest the notice .1° Cloyd die d

before trial began, and Bonnie was made the special administrato r

of his estate . Trial was finally held in Los Angeles .

OPINIO N

I .

Taxability of the Cal-Almond Asset .Sal e

The Angles argue that all,these maneuverings made the gain

Cloyd otherwise would have realized and recognized in 1995

disappear . We disagree .

The first reason this magic fails is that we specificall y

find there was no private annuity in existence in 1995 . The

annuity agreements weren't actually signed on October 25 , 1995 at

the meeting in the BVI .

Cloyd didn ' t attend that meeting-he

sent Norman as his representative .

Yet all the parties agre e

that it is Cloyd's signature on the documents, not Norman'Is .

From this, we find that the documents weren't signed until after

October 25 . And since nobody seems to have seen a signedjcopy o f

9( . . .continued

) Rule references are to the Tax Court Rules of Practice an d

Procedure .

The notice of deficiency incorrectly charged a 20-percent

penalty twice--once for substantial understatement under section

6662(b)(2), and again for negligence under section 6662(b)(1) .

Section 6662 allows only a single 20-percent penalty, .as the

Commissioner has since conceded .

to Barring a stipulation to the contrary, that means any

appeal from this decision will be to the District of Columbia

Circuit . Sec . 7482(b)(1) and-(2) .

16 the annuity documents until pretrial preparation, we find it more

likely then not that they weren't signed until long after 1995 .

Even if the agreements had actually been signed in 1995 ,

however, we would still find that the private annuity didn't

really exist . Molseberry didn't receive any funding with which

to pay the annuities until July 1996--four months

after the first

annuity payments were due . There also weren't any checks or

statements that might have led us at least to infer the

annuities' existence . We therefore find by a preponderance of

the evidence that Cloyd had not even one annuity from Molseberry

in 1995 .

Another reason this sleight-of-hand fails is that Cloyd had

complete control over Molseberry . Each of the three nominal

Padang shareholders--ICC, ATC, and Codan--required the assurance

that it would receive retainer fees before it agreed to subscribe

to :shares of .Padang stock . In Codan's case, the . retainer was

annual and was subject to review and adjustment "in line with the

duties performed ." Each company's retainer fee--as well as the

ongoing maintenance fees for both Padang and Molseberry--was paid

by Cal-Almond through Schneider's company, Wilshire Trust, after

personal review and approval by Cloyd . Cloyd completely

controlled the Padang shareholders ., none of which had any purpose

apart from owning Padang shares . This means those shareholders

were nothing more than nominees for Cloyd . Cloyd himself was the

- 17 indirect owner, and controlled Molseberry--a conclusion which is

also . supported by the fact that Cloyd handpicked each of the

companies with the idea that they would ultimately do what he

wanted them to do with the money . The evidence even showd that

Cloyd at first thought he would use a company called Trust Net to

manage Padang--until that company looked like it would act

independently, whereupon Cloyd cut it off and began looking fo r

more pliable companies to receive his money .

What made Cloyd, his lawyers, and Schneider think they could

make all of this work was a pair of Ninth Circuit cases :

Ster n

v . Commissioner , 747 F .2d 555 (9th Cir . 1984), revg . an d

remanding 77 T .C . 614 (1981), and Syufy v . United States,

F .2d 1457 (9th Cir . 1987) . In

818

Stern , the taxpayers transferred

appreciated stock into two foreign trusts in exchange forIprivate

annuities .

Svufv involved a similar scenario but with a single

foreign trust and a single annuity . In both cases, the trusts

had a foreign trustee which the court found to be completel y

independent from the respective taxpayers . The court also found

.in both cases that the taxpayers did not retain sufficien t

control over the property in the trust to warrant treating the

transaction as a transfer in trust subject to a retained income

interest, especially when the purpose of the transactions, was t o

minimize estate taxes and not to avoid income taxes . A

18 result, the Ninth Circuit held the transactions in both Stern and

Syufy to be transfers in exchange for annuities .

In drawing on these two cases, however, the participants in

the Angles' transaction failed to heed the court's reasoning . As

we've already noted, Cloyd transferred the funds to Molseberry

before a trust was in place ; without a transfer into a trust, the

tax analysis becomes quite different . (The taxpayers in Stern

and Syufy were also found to have legitimate reasons other than

income-tax avoidance for their actions . )

Bebause Stern and Syufy do not apply in this situation, we

are free to find .that Cloyd retained control over Molseberry .

Perhaps our findings are best summed up by the Ninth Circuit

itself in a different case : "While it is possible that a

rational person would send millions of dollars overseas and

retain absolutely no control over the assets, we share the

district court's skepticism ."

FTC v . Affordable Media, LLC , 17 9

F .3d 1228, 1241 (9th Cir . 1999) .

But if Cloyd's deal wasn't an exchange of stock for a

private annuity, what exactly was it? The only plausible answer

is the Commissioner's : Cloyd's transfer of his Cal-Almond stock

to Molseberry was a contribution to its capital . Molseberry was

a foreign corporation and, as we have already found, Cloyd was

the indirect owner of the Molseberry stock whose shareholders of

record were his mere nominees .

- 19 Section 351(a) provides that there is no gain or loss i

recognized when one transfers property to a controlled

corporation--i .e ., a corporation in which one owns at least 8 0

percent of both the total voting power and the number of

outstanding shares . Sec . 368(c) . But Cloyd's transaction falls

within section 367(c)(2), which applies to foreign corporations

and limits the applicability of section 351(a) when the perso n

transferring the property owns "at least 80 percent of the tota l

combined voting power of all classes of stock of such

f

corporation ." Cloyd might argue that Molseberry was owned b y

Padang and Padang by three other entities, but the Code doesn't

let him do so successfully--indirect ownership of a corpoatio n

is a form of constructive ownership described in section

318(a)(2)(C) . And we specifically hold that, as elsewhere in tax

law, indirect ownership includes situations where a nominee hold s

title for the actual, beneficial owner . See, e .g ., ;

Merino v .

Commissioner , 196 F .3d 147, 150 (3d Cir . 1999), affg . T .C! Memo .

1997-385 ;

Paymer v . Commissioner , 150 F .2d 334, 337 (2d .Cir .

1945) (nominee corporation is one serving "no business purpose

* * and * * * intended to serve only as a blind to deter the

creditors") ; sec . 1 .482-1(i)(4), Income Tax Regs . (in determining

whether two entities are "controlled * * . * by the same interests "

for purposes of sec . 482, controlled means "any kind of control,

direct or indirect, whether legally enforceable or not, and

20 however exercisable or exercised, including control resulting

from the actions of two or more taxpayers acting in concert or

with a common goal or purpose") . Section 367(c)(2) provides that

when a controlled corporation is also foreign ; the transfer of

property is treated as if it were an exchange for stock in the

foreign corporation equal in value to the fair market value of

the property transferred . This has the effect of forcing an

immediate recognition of any gain or loss which one would have

realized upon selling the property to a third party . In other

,words, under section 367(c)(2), Cloyd has to recognize the entire

gain on the Cal-Almond stock he transferred to Molseberry in 1995

rather than recognizing it only over the course of any annuity .

In 1995, there was only one exception to section 367(c)(2)'s .

recognition rules, in the temporary regulation now numbered

section 1 .367(a)-3(c), income Tax Regs . That exception required

that the U .S . transferor receive less than 50 percent of "the

total voting power and the total value of the stock of the

transferee-foreign corporation" in exchange for domestic stock .

Since Cloyd constructively received all of the voting power and

all of the value of Molseberry's stock, he does not qualify for

this exception . This means that we must treat Cloyd as if he

received Molseberry stock equal to the fair market value of his

Cal-Almond stock when he transferred it to the corporation .

Cloyd therefore realized gain on the sale of Cal-Almond's assets

- 21 under section 367, and must recognize that gain in 1995 unde r

section 1001 .

II .

The Section 6662 Penalt y

The Angles have conceded that they substantially understate d

their income tax liability for 1995 within the meaning of sectio n

6662(d)(1)(A) .11 However, they claim that they are not subject

to the 20-percent accuracy-related penalty because, underiall th e

facts and circumstances, they acted with reasonable cause

and i n

good faith by relying on the professional advice of both Norman

and Schneider .

See sec . 6664(c)(1) ; sec . 1 .6664-4(b)(1),~(c) ,

Income Tax Regs .

We disagree that either Norman or Schneider specifically

advised the Angles on how to complete their tax return in11995 .

Although the record'shows numerous opinion letters from both

Norman and Schneider regarding the transaction as a whole, eac h

of those letters is careful to point out that the tax benefits ,

being described would be valid only if each

recommended step wa s

followed to the letter . It was left to Cloyd to determine for

himself whether he had followed those steps and could treat th e

transaction as described .

11 Sec . 6662(d)(1)(A) states that a substantial !

understatement occurs when the understatement "exceeds the

greater of--(i) 10 percent of the tax required to be shown on th e

return for the taxable year, or (ii) $5,000 ."

- 22 Even if it we found that both Norman and Schneider did

specifically advise the Angles about their 1995 tax liability, we

still find that the Angles didn't reasonably rely on that advice . .

We make this finding primarily on the fact that Cloyd didn' t

follow the steps outlined for him despite a warning that by not

.doing so, he would subject himself to taxes . See Garfield v .

Commissioner , T .C . Memo . 2006-267 (no evidence that taxpayer

followed or sought professional advice) ;

O' .Connor v .

Commissioner , T .C . Memo . 2001-90 (no reasonable reliance when

taxpayer ignored accountant's advice) .

We therefore find that the Angles did not act with

reasonable cause and in good faith . They are subject to a 20percent accuracy-related penalty under section 6662(a) on the

entire underpayment .

Decision will be entere d

under Rule 155 .