                       113 T.C. No. 17



                UNITED STATES TAX COURT



              COMPAQ COMPUTER CORPORATION
            AND SUBSIDIARIES, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 24238-96.                 Filed September 21, 1999.



     In a prearranged transaction designed to eliminate
typical market risks, P purchased and immediately
resold American Depository Receipts (ADR's) of a
foreign corporation on the floor of the NYSE. As a
result of the transaction, P was the shareholder of
record of 10 million ADR's on the dividend record date
and received a dividend of $22,545,800 less withheld
foreign taxes of $3,381,870. P also recognized a
$20,652,816 capital loss on the sale of the ADR's,
which was offset against previously realized capital
gains. The net cash-flow from the transaction, without
regard to tax consequences, was a $1,486,755 loss.
Held: The transaction lacked economic substance, and
the foreign tax credit claimed by P will be disallowed.
Held further: An accuracy-related penalty will be
imposed due to petitioner's negligence.
                               - 2 -


     Mark A. Oates, John M. Peterson, Jr., James M. O'Brien,

Owen P. Martikan, Paul E. Schick, Robert S. Walton, Tamara L.

Frantzen, Erika S. Schechter, A. Duane Webber, David A. Waimon,

Lafayette G. Harter III, and Steven M. Surdell, for petitioner.

     Dennis M. Kelly, Ginny Y. Chung, and Rebecca I. Rosenberg,

for respondent.

     COHEN, Chief Judge:   The issues addressed in this opinion

are whether petitioner's purchase and resale of American

Depository Receipts (ADR's) in 1992 lacked economic substance and

whether petitioner is liable for an accuracy-related penalty

pursuant to section 6662(a).   (In a separate opinion, Compaq

Computer Corp. & Subs. v. Commissioner, T.C. Memo. 1999-220, we

held that income relating to printed circuit assemblies should

not be reallocated under section 482 to petitioner from its

Singapore subsidiary for its 1991 and 1992 fiscal years.

Petitioner has also filed a Motion for Summary Judgment on the

issue of whether petitioner is entitled to foreign tax credits

for certain United Kingdom Advance Corporation Tax payments.)

Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.
                               - 3 -


                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.    Since

1982, petitioner has been engaged in the business of designing,

manufacturing, and selling personal computers.    Details

concerning petitioner's business operations are set forth in T.C.

Memo. 1999-220 and are not repeated here.

     Petitioner occasionally invested in the stock of other

computer companies.   In 1992, petitioner held stock in Conner

Peripherals, Inc. (Conner Peripherals), a publicly traded,

nonaffiliated computer company.   Petitioner sold the Conner

Peripherals stock in July 1992, recognizing a long-term capital

gain of $231,682,881.

     Twenty-First Securities Corporation (Twenty-First), an

investment firm specializing in arbitrage transactions, learned

of petitioner's long-term capital gain from the sale of Conner

Peripherals, and on August 13, 1992, Steven F. Jacoby (Jacoby), a

broker and account executive with Twenty-First, mailed a letter

to petitioner soliciting petitioner's business.    The letter

stated that Twenty-First "has uncovered a number of strategies

that take advantage of a capital gain", including a Dividend

Reinvestment Arbitrage Program (DRIP) and a "proprietary

variation on the DRIP", the ADR arbitrage transaction (ADR

transaction).
                                - 4 -


     An ADR (American Depository Receipt) is a trading unit

issued by a trust, which represents ownership of stock in a

foreign corporation that is deposited with the trust.   ADR's are

the customary form of trading foreign stocks on U.S. stock

exchanges, including the New York Stock Exchange (NYSE).    The ADR

transaction involves the purchase of ADR's "cum dividend",

followed by the immediate resale of the same ADR's "ex dividend".

"Cum dividend" refers to a purchase or sale of a share of stock

or an ADR share with the purchaser entitled to a declared

dividend (settlement taking place on or before the record date of

the dividend).    "Ex dividend" refers to the purchase or sale of

stock or an ADR share without the entitlement to a declared

dividend (settlement taking place after the record date).

     James J. Tempesta (Tempesta) was an assistant treasurer in

petitioner's treasury department in 1992.   He received his

undergraduate degree in philosophy and government from Georgetown

University and his master's degree in finance and accounting from

the University of Texas.   Tempesta's responsibilities in

petitioner's treasury department included the day-to-day

investment of petitioner's cash reserves, including the

evaluation of investment proposals from investment bankers and

other institutions.   He was also responsible for writing

petitioner's investment policies that were in effect during

September 1992.   Petitioner's treasury department primarily
                               - 5 -


focused on capital preservation, typically investing in overnight

deposits, Eurodollars, commercial paper, and tax-exempt

obligations.

     On September 15, 1992, Tempesta and petitioner's treasurer,

John M. Foster (Foster), met with Jacoby and Robert N. Gordon

(Gordon), president of Twenty-First, to discuss the strategies

proposed in the August 13, 1992, letter from Twenty-First.    In a

meeting that lasted approximately an hour, Jacoby and Gordon

presented the DRIP strategy and the ADR transaction.   Following

the meeting, Tempesta and Foster discussed the transactions with

Darryl White (White), petitioner's chief financial officer.     They

decided not to engage in the DRIP investment but chose to go

forward with the ADR transaction, relying primarily on Tempesta's

recommendation.   Tempesta notified Twenty-First of this decision

on September 16, 1992.

     Although cash-flow was generally important to petitioner's

investment decisions, Tempesta did not perform a cash-flow

analysis before agreeing to take part in the ADR transaction.

Rather, Tempesta's investigation of Twenty-First and the ADR

transaction, in general, was limited to telephoning a reference

provided by Twenty-First and reviewing a spreadsheet provided by

Jacoby that analyzed the transaction.   Tempesta shredded the

spreadsheet a year after the transaction.
                               - 6 -


     Joseph Leo (Leo) of Twenty-First was responsible for

arranging the execution of the purchase and resale trades of

ADR's for petitioner.   Bear Stearns & Co., Inc. (Bear Stearns),

was used as the clearing broker for petitioner's trades, and the

securities selected for the transaction were ADR shares of Royal

Dutch Petroleum Company (Royal Dutch).   Royal Dutch ordinary

capital shares were trading in 21 organized markets throughout

the world in 1992, but primarily on the NYSE in the United States

as ADR's.   Before agreeing to enter into the transaction,

petitioner had no specific knowledge of Royal Dutch, and

Tempesta's research of Royal Dutch was limited to reading in the

Wall Street Journal that Royal Dutch declared a dividend and to

observing the various market prices of Royal Dutch ADR's.

     In preparation for the trades, Leo determined the number of

Royal Dutch ADR's to be included in each purchase and resale

trade.   He also selected the market prices to be paid, varying

the prices in different trades so the blended price per share

equaled the actual market price plus the net dividend.   Leo did

not, however, discuss the size of the trades or the prices

selected for the trades with any employee or representative of

petitioner.   Leo also chose to purchase the Royal Dutch ADR's

from Arthur J. Gallagher and Company (Gallagher).   Gallagher had

been a client of Twenty-First since 1985 and participated in

various investment strategies developed by Twenty-First over the
                                - 7 -


years.   During 1991, Gallagher participated in several ADR

transaction trades as the purchaser of the ADR's.    Tempesta had

no knowledge of the identity of the seller of ADR's.    He only

knew that the seller was a client of Twenty-First.

     On September 16, 1992, Leo instructed ABD-N.Y., Inc. (ABD),

to purchase 10 million Royal Dutch ADR's on petitioner's behalf

from Gallagher on the floor of the NYSE.    He also instructed ABD

to resell the 10 million Royal Dutch ADR's to Gallagher

immediately following the purchase trades.    The purchase trades

were made in 23 separate cross-trades of approximately 450,000

ADR's each with special "next day" settlement terms pursuant to

NYSE rule 64.    The aggregate purchase price was $887,577,129, cum

dividend.

     ABD executed the 23 sale trades, selling the Royal Dutch

ADR's back to Gallagher, immediately following the related

purchase trade.   Accordingly, each purchase trade and its related

sale trade were completed before commencing the next purchase

trade.   The sales transactions, however, had regular settlement

terms of 5 days, and the aggregate sales price was $868,412,129,

ex dividend.    The 23 corresponding purchase and resale trades

were completed in about an hour between approximately 2:58 p.m.

and 4:00 p.m.

     Leo had instructed the ABD floor brokers to execute the

trades only if the prices selected were within the range of the
                               - 8 -


current market prices.   Thus, when, between the sixth and seventh

trades, the market price changed, Leo modified the price for

subsequent trades to compensate for the change.   In addition,

NYSE rule 76 required an open outcry for each cross-trade, and

NYSE rule 72 allowed other traders on the floor or the

"specialist" responsible for making the cross-trades to break up

the transaction by taking all or part of the trade.   However, for

cross-trades priced at the market price, there was no incentive

to break up the transaction.

     Pursuant to the "next day" settlement rules, the purchase

cross-trades were settled between petitioner and Gallagher on

September 17, 1992.   On that date, Gallagher's account with Bear

Stearns was credited $887,547,543 for the purchase trades,

including a reduction for Securities and Exchange Commission fees

(SEC fees) of $29,586.   Gallagher was subsequently reimbursed for

the SEC fees.   Also on September 17, 1992, petitioner transferred

$20,651,996 to Bear Stearns, opening a margin account.

     On September 18, 1992, at 10:47 a.m., petitioner complied

with the applicable margin requirements, transferring $16,866,571

to its margin account with Bear Stearns.   The margin requirement

for purchase and sale transactions completed on the same day was

50 percent of the purchase price of the largest trade executed on

that day.   It was not necessary to make payments for each

completed trade.   Accordingly, this wire transfer was made by
                                - 9 -


petitioner to demonstrate its financial ability to pay under the

applicable margin rules.    The $16,866,571 was transferred back to

petitioner that same day at 1:39 p.m.

     Pursuant to the regular settlement rules, the resale cross-

trades were settled between petitioner and Gallagher on

September 21, 1992.   The total selling price credited to

petitioner's account with Bear Stearns was $868,412,129 (before

commissions and fees).    Expenses incurred by petitioner with

respect to the purchase and resale trades included:    SEC fees of

$28,947, interest of $457,846, a margin writeoff of $37, and

commissions of $998,929.    Petitioner had originally agreed to pay

Twenty-First commissions of $1,000,000, but Twenty-First adjusted

its commissions by $1,070.55 to offset computational errors in

calculating some of the purchase trades.

     Due to the different settlement dates, petitioner was the

shareholder of record of 10 million Royal Dutch ADR's on the

dividend record date and was therefore entitled to a dividend of

$22,545,800.   On October 2, 1992, Royal Dutch paid the declared

dividend to shareholders of record as of September 18, 1992,

including petitioner.    Contemporaneously with the dividend, a

corresponding payment was made to the Netherlands Government

representing withholding amounts for dividends paid to U.S.

residents within the meaning of the United States-Netherlands Tax

Treaty, Convention With Respect to Taxes on Income and Certain
                                - 10 -


Other Taxes, Apr. 29, 1948, U.S.-Neth., art. VII, para. 1, 62

Stat. 1757, 1761.   The withholding payment equaled 15 percent of

the declared dividend, $3,381,870.       Accordingly, a net dividend

of $19,163,930 was deposited into petitioner's margin account at

Bear Stearns and wired to petitioner on October 2, 1992.

     On its 1992 Federal income tax return, petitioner reported

the loss on the purchase and resale of Royal Dutch ADR's as a

short-term capital loss in the amount of $20,652,816, calculated

as follows:

                Adjusted basis       $888,535,869
                Amount realized       867,883,053
                Capital loss         $ 20,652,816

Petitioner also reported dividend income in the amount of

$22,546,800 and claimed a foreign tax credit of $3,382,050 for

the income tax withheld and paid to the Netherlands Government

with respect to the dividend.

                     ULTIMATE FINDINGS OF FACT

     Every aspect of petitioner's ADR transaction was

deliberately predetermined and designed by petitioner and

Twenty-First to yield a specific result and to eliminate all

economic risks and influences from outside market forces on the

purchases and sales in the ADR transaction.

     Petitioner had no reasonable possibility of a profit from

the ADR transaction without the anticipated Federal income tax

consequences.
                              - 11 -


     Petitioner had no business purpose for the purchase and sale

of Royal Dutch ADR's apart from obtaining a Federal income tax

benefit in the form of a foreign tax credit while offsetting the

previously recognized capital gain.

                              OPINION

     Respondent argues that petitioner is not entitled to the

foreign tax credit because petitioner's ADR transaction had no

objective economic consequences or business purpose other than

reduction of taxes.   Petitioner argues that it is entitled to the

foreign tax credit because it complied with the applicable

statutes and regulations, that the transaction had economic

substance, and that, in any event, the economic substance

doctrine should not be applied to deny a foreign tax credit.

     In Frank Lyon Co. v. United States, 435 U.S. 561, 583-584

(1978), the Supreme Court stated that "a genuine multiple-party

transaction with economic substance * * * compelled or encouraged

by business or regulatory realities, * * * imbued with tax-

independent considerations, and * * * not shaped solely by tax-

avoidance features" should be respected for tax purposes.

Innumerable cases demonstrate the difference between (1) closing

out a real economic loss in order to minimize taxes or arranging

a contemplated business transaction in a tax-advantaged manner

and (2) entering into a prearranged loss transaction designed

solely for the reduction of taxes on unrelated income.   In the
                              - 12 -


former category are Cottage Sav. Association v. Commissioner, 499

U.S. 554 (1991); and Esmark, Inc. & Affiliated Cos. v.

Commissioner, 90 T.C. 171 (1988), affd. without published opinion

886 F.2d 1318 (7th Cir. 1989).   In the latter category are ACM

Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), affg.

in part T.C. Memo. 1997-115; Goldstein v. Commissioner, 364 F.2d

734 (2d Cir. 1966); and Friendship Dairies, Inc. v. Commissioner,

90 T.C. 1054 (1988).   Referring to tax shelter transactions in

which a taxpayer seeks to use a minimal commitment of funds to

secure a disproportionate tax benefit, the Court of Appeals for

the Seventh Circuit stated, in Saviano v. Commissioner, 765 F.2d

643, 654 (7th Cir. 1985), affg. 80 T.C. 955 (1983):

     The freedom to arrange one's affairs to minimize taxes
     does not include the right to engage in financial
     fantasies with the expectation that the Internal
     Revenue Service and the courts will play along. The
     Commissioner and the courts are empowered, and in fact
     duty-bound, to look beyond the contrived forms of
     transactions to their economic substance and to apply
     the tax laws accordingly. * * *

     Petitioner repeatedly argues, and asks the Court to find,

that it could not have had a tax savings or tax benefit purpose

in entering into the ADR transaction because:

          In this case, a tax savings or tax benefit purpose
     cannot be attributed to Compaq because Compaq did not
     enjoy any tax reduction or other tax benefit from the
     transaction. Compaq's taxable income increased by
     approximately $1.9 million as a result of the Royal
     Dutch ADR arbitrage. Compaq's worldwide tax liability
     increased by more than $640,000 as a direct result of
     the Royal ADR arbitrage. The reason for this increase
                              - 13 -


     in income taxes is obvious--Compaq realized a net
     profit with respect to the Royal Dutch ADR arbitrage.
     That net profit, appropriately, was subject to tax.

Petitioner's calculation of its alleged profit is as

follows:

   ADR transaction:
      ADR purchase trades          ($887,577,129)
      ADR sale trades                868,412,129
       Net cash from ADR transaction              ($19,165,000)
   Royal Dutch dividend                             22,545,800
   Transaction costs                                (1,485,685)
   PRETAX PROFIT                                    $1,895,115

Petitioner asserts:

          Stated differently, the reduction in income tax
     received by the United States was not the result of a
     reduction in income tax paid by Compaq. Each dollar of
     income tax paid to the Netherlands was just as real,
     and was the same detriment to Compaq, as each dollar of
     income tax paid to the United States. Even
     Respondent's expert acknowledged this detriment, and
     that Compaq's worldwide income tax increased as a
     result of the Royal Dutch ADR arbitrage. A "tax
     benefit" can be divined from the transaction only if
     the income tax paid to the Netherlands with respect to
     Royal Dutch dividend is ignored for purposes of
     computing income taxes paid, but is included as a
     credit in computing Compaq's U.S. income tax liability.
     Such a result is antithetical to the foreign tax credit
     regime fashioned by Congress.

          In the complete absence of any reduction in income
     tax, it is readily apparent that Compaq could not have
     engaged in the transaction solely for the purpose of
     achieving such an income tax reduction.

Petitioner's rationale is that it paid $3,381,870 to the

Netherlands through the withheld tax and paid approximately

$640,000 in U.S. income tax on a reported "pretax profit" of

approximately $1.9 million.   (The $640,000 amount is petitioner's
                               - 14 -


approximation of U.S. income tax on $1.9 million in income.)     If

we follow petitioner's logic, however, we would conclude that

petitioner paid approximately $4 million in worldwide income

taxes on that $1.9 million in profit.

     Petitioner cites several cases, including Levy v.

Commissioner, 91 T.C. 838, 859 (1988); Gefen v. Commissioner, 87

T.C. 1471, 1492 (1986); Pearlstein v. Commissioner, T.C. Memo.

1989-621; and Rubin v. Commissioner, T.C. Memo. 1989-484, that

conclude that the respective transactions had economic substance

because there was a reasonable opportunity for a "pretax profit".

These cases, however, merely use "pretax profit" as a shorthand

reference to profit independent of tax savings, i.e., economic

profit.    They do not involve situations, such as we have in this

case, where petitioner used tax reporting strategies to give the

illusion of profit, while simultaneously claiming a tax credit in

an amount (nearly $3.4 million) that far exceeds the U.S. tax (of

$640,000) attributed to the alleged profit, and thus is available

to offset tax on unrelated transactions.   Petitioner's tax

reporting strategy was an integrated package, designed to produce

an economic gain when--and only when--the foreign tax credit was

claimed.   By reporting the gross amount of the dividend, when

only the net amount was received, petitioner created a fictional

$1.9 million profit as a predicate for a $3.4 million tax credit.
                              - 15 -


     While asserting that it made a "real" payment to the

Netherlands in the form of the $3,381,870 withheld tax,

petitioner contends that that withholding tax should be

disregarded in determining the U.S. tax effect of the transaction

and the economic substance of the transaction.   Respondent,

however, persuasively demonstrates that petitioner would incur a

prearranged economic loss from the transaction but for the

foreign tax credit.

     The following cash-flow analysis demonstrates the inevitable

economic detriment to petitioner from engaging in the ADR

transaction:

   Cash-flow from ADR transaction:
      ADR purchase trades          ($887,577,129)
      ADR sale trades                868,412,129
       Net cash from ADR transaction              ($19,165,000)

   Cash-flow from dividend:
      Gross dividend                   22,545,800
      Netherlands withholding tax      (3,381,870)
       Net cash from dividend                         19,163,930
   OFFSETTING CASH-FLOW RESIDUAL                          (1,070)

   Cash-flow from transaction costs:
      Commissions                      (1,000,000)
      Less: Adjustment                      1,071
      SEC fees                            (28,947)
      Margin writeoff                          37
      Interest                           (457,846)
       Net cash from transaction costs                (1,485,685)

   NET ECONOMIC LOSS                                 ($1,486,755)

The cash-flow deficit arising from the transaction, prior to use

of the foreign tax credit, was predetermined by the careful and
                              - 16 -


tightly controlled arrangements made between petitioner and

Twenty-First.   The scenario was to "capture" a foreign tax credit

by timed acquisition and sale of ADR's over a 5-day period in

which petitioner bought ADR's cum dividend from Gallagher and

resold them ex dividend to Gallagher.   Petitioner was acquiring a

foreign tax credit, not substantive ownership of Royal Dutch

ADR's.   See Friendship Dairies, Inc. v. Commissioner, supra at

1067.

     Petitioner argues that there were risks associated with the

ADR transaction, but neither Tempesta nor any other

representative of petitioner conducted an analysis or

investigation regarding these alleged concerns.   Transactions

that involve no market risks are not economically substantial

transactions; they are mere tax artifices.   See Yosha v.

Commissioner, 861 F.2d 494, 500-501 (7th Cir. 1988), affg. Glass

v. Commissioner, 87 T.C. 1087 (1986).   Tax-motivated trading

patterns generally indicate a lack of economic substance.   See

Sheldon v. Commissioner, 94 T.C. 738, 766, 769 (1990).   The

purchase and resale prices were predetermined by Leo, and the

executing floor brokers did not have authority to deviate from

the predetermined prices even if a price change occurred.   In

addition, the ADR transaction was divided into 23 corresponding

purchase and resale cross-trades that were executed in

succession, almost simultaneously, and within an hour on the
                                - 17 -


floor of the NYSE.     Thus, there was virtually no risk of price

fluctuation.   Special next-day settlement terms and large blocks

of ADR's were also used to minimize the risk of third parties

breaking up the cross-trades, and, because the cross-trades were

at the market price, there was no risk of other traders breaking

up the trades.   None of the outgoing cash-flow resulted from

risks.   Accordingly, we have found that this transaction was

deliberately predetermined and designed by petitioner and Twenty-

First to yield a specific result and to eliminate all market

risks.

     To satisfy the business purpose requirement of the economic

substance inquiry, “the transaction must be rationally related to

a useful nontax purpose that is plausible in light of the

taxpayer's conduct and * * * economic situation.”      AMC

Partnership v. Commissioner, T.C. Memo. 1997-115, affd. in part,

revd. in part, and remanded 157 F.3d 231 (3d Cir. 1998); see also

Levy v. Commissioner, supra at 854.      This inquiry takes into

account whether the taxpayer conducts itself in a realistic and

legitimate business fashion, thoroughly considering and analyzing

the ramifications of a questionable transaction, before

proceeding with the transaction.     See UPS of Am. v. Commissioner,

T.C. Memo. 1999-268.

     Petitioner contends that it entered into the ADR transaction

as a short-term investment to make a profit apart from tax
                             - 18 -


savings, but the objective facts belie petitioner's assertions.

The ADR transaction was marketed to petitioner by Twenty-First

for the purpose of partially shielding a capital gain previously

realized on the sale of Conner Peripherals stock.    Petitioner's

evaluation of the proposed transaction was less than businesslike

with Tempesta, a well-educated, experienced, and financially

sophisticated businessman, committing petitioner to this

multimillion-dollar transaction based on one meeting with Twenty-

First and on his call to a Twenty-First reference.   As a whole,

the record indicates and we conclude that petitioner was

motivated by the expected tax benefits of the ADR transaction,

and no other business purpose existed.

     Petitioner also contends that the ADR transaction does not

warrant the application of the economic substance doctrine

because the foreign tax credit regime completely sets forth

Congress' intent as to allowable foreign tax credits.   Petitioner

argues that an additional economic substance requirement was not

intended by Congress and should not be applied in this case.

     Congress creates deductions and credits to encourage certain

types of activities, and the taxpayers who engage in those

activities are entitled to the attendant benefits.   See, e.g.,

Leahy v. Commissioner, 87 T.C. 56, 72 (1986); Fox v.

Commissioner, 82 T.C. 1001, 1021 (1984).   The foreign tax credit

serves to prevent double taxation and to facilitate international
                              - 19 -


business transactions.   No bona fide business is implicated here,

and we are not persuaded that Congress intended to encourage or

permit a transaction such as the ADR transaction, which is merely

a manipulation of the foreign tax credit to achieve U.S. tax

savings.

     Finally, petitioner asserts that the enactment of section

901(k) by the Taxpayer Relief Act of 1997, Pub. L. 105-34, sec.

1053(a), 111 Stat. 941, also indicates that Congress did not

intend for the economic substance doctrine to apply under the

facts of this case.   Section 901(k)(1) provides that a taxpayer

must hold stock (or an ADR) for at least 16 days of a prescribed

30-day period including the dividend record date, in order to

claim a foreign tax credit with respect to foreign taxes withheld

at the source on foreign dividends.    If the taxpayer does not

meet these holding requirements, the taxpayer may claim a

deduction for the foreign taxes paid if certain other

requirements are met.

     Section 901(k) does not change our conclusion in this case.

That provision was passed in 1997 and was effective for dividends

paid or accrued after September 4, 1997.    The report of the

Senate Finance Committee indicates that "No inference is intended

as to the treatment under present law of tax-motivated

transactions intended to transfer foreign tax credit benefits."

S. Rept. 105-33, 175, 177 (1997).   A transaction does not avoid
                              - 20 -


economic substance scrutiny because the transaction predates a

statute targeting the specific abuse.    See, e.g., Krumhorn v.

Commissioner, 103 T.C. 29, 48-50 (1994); Fox v. Commissioner,

supra at 1026-1027.   Accordingly, section 901(k), enacted 5 years

after the transaction at issue, has no effect on the outcome of

this case.

Accuracy-Related Penalty

     Respondent determined that petitioner is liable for the

section 6662(a) penalty for 1992.   Section 6662(a) imposes a

penalty in an amount equal to 20 percent of the underpayment of

tax attributable to one or more of the items set forth in section

6662(b).   Respondent asserts that the underpayment attributable

to the ADR transaction was due to negligence.   See sec.

6662(b)(1).   "Negligence" includes a failure to make a reasonable

attempt to comply with provisions of the internal revenue laws or

failure to do what a reasonable and ordinarily prudent person

would do under the same circumstances.   See sec. 6662(c);

Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967),

affg. on this issue 43 T.C. 168 (1964); sec. 1.6662-3(b)(1),

Income Tax Regs.   Petitioner bears the burden of proving that

respondent's determinations are erroneous.   See Rule 142(a);

Freytag v. Commissioner, 904 F.2d 1011, 1017 (5th Cir. 1990),

affg. 89 T.C. 849, 887 (1987), affd. 501 U.S. 868 (1991).
                                - 21 -


     The accuracy-related penalty does not apply with respect to

any portion of an underpayment if it is shown that there was

reasonable cause for such portion of an underpayment and that the

taxpayer acted in good faith with respect to such portion.       See

sec. 6664(c)(1).     The determination of whether the taxpayer acted

with reasonable cause and in good faith depends upon the

pertinent facts and circumstances.       See sec. 1.6664-4(b)(1),

Income Tax Regs.     The most important factor is the extent of the

taxpayer's effort to assess the proper tax liability for the

year.    See id.

        Respondent argues that petitioner is liable for the

accuracy-related penalty because petitioner negligently

disregarded the economic substance of the ADR transaction;

petitioner failed to meet its burden of proving that the

underpayment was not due to negligence; and petitioner failed to

offer evidence that there was reasonable cause for its return

position for the ADR transaction or that it acted in good faith

with respect to such item.     Petitioner argues that there is no

basis for a negligence penalty because the return position was

reasonable, application of the economic substance doctrine to the

ADR transaction is "inherently imprecise", and application of the

economic substance doctrine to disregard a foreign tax credit

raises an issue of first impression.       We agree with respondent.
                               - 22 -


     In this case, Tempesta, Foster, and White were sophisticated

professionals with investment experience and should have been

alerted to the questionable economic nature of the ADR

transaction.   They, however, failed to take even the most

rudimentary steps to investigate the bona fide economic aspects

of the ADR transaction.   See Freytag v. Commissioner, supra.     As

set forth in the findings of fact, petitioner did not investigate

the details of the transaction, the entity it was investing in,

the parties it was doing business with, or the cash-flow

implications of the transaction.    Petitioner offered no evidence

that it satisfied the "reasonable and ordinarily prudent person"

standard or relied on the advice of its tax department or

counsel.    If any communications occurred in which consideration

was given to the correctness of petitioner's tax return position

when the return was prepared and filed, petitioner has chosen not

to disclose those communications.   We conclude that petitioner

was negligent, and the section 6662(a) penalty is appropriately

applied.

     Our holding in this opinion will be incorporated into the

decision to be entered in this case when all other issues are

resolved.
