                         T.C. Memo. 1995-546



                      UNITED STATES TAX COURT



   GEORGE GEORGIOU AND JUDITH GEORGIOU A.K.A. JUDY GEORGIOU, ET
AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 19395-93, 19396-93,     Filed November 16, 1995.
                 19397-93.



     Richard J. Sideman and Wendy Abkin, for petitioners.

     Debra K. Estrem, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     COHEN, Judge:   In these consolidated cases, respondent

determined deficiencies in and additions to petitioners' Federal

income tax as follows:

     1
      Cases of the following petitioners are consolidated
herewith: Kolonaki Imports, Inc., docket No. 19396-93; and
Georgiou Retail Stores, docket No. 19397-93.
                                    - 2 -
                                         Additions to Tax & Penalties
                                  Sec.         Sec.          Sec.     Sec.
Docket No.   Year    Deficiency   6653(a)(1)   6653(a)(2)    6661     6662(a)

19395-93     1989    $173,021        --          --         --       $ 34,604
(George &    1990     667,786        --          --         --        133,557
Judith
Georgiou)

19396-93     1989      88,493     $4,425      To be        $22,123      --
(Kolonaki                                     determined
Imports,     1990     555,515        --          --           --      111,103
Inc.)

19397-93     1989      44,261      2,214      To be         11,065       --
(Georgiou                                     determined
Retail
Stores)

(References to the tax year for the corporations are to the
applicable fiscal year.)

     Unless otherwise indicated, all section references are to

the Internal Revenue Code as amended and in effect for the years

in issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

     After concessions, the issues remaining for decision as to

Kolonaki Imports, Inc. (Kolonaki), are:           Whether Kolonaki was

qualified to file a consolidated return with Judy Alexander, Inc.

(JAI), a corporation wholly owned by George Georgiou (Georgiou),

for the year ended September 30, 1990; whether Kolonaki is liable

for a penalty under section 6662(a) for 1990; and whether

Kolonaki is liable for additions to tax under sections 6653(a)(1)

and 6661 for 1989.       The issues remaining for decision as to

Georgiou are:       Whether amounts transferred to Georgiou from

Kolonaki in 1989 and 1990 constituted loans or constructive

dividends; whether a $100,000 home interest deduction claimed by
                               - 3 -

Georgiou in 1990 can be recharacterized as a business interest

expense under section 163(a); whether ownership of JAI stock was

transferred from Georgiou to Kolonaki during 1989 or 1990,

creating a dividend under section 304; and whether Georgiou is

liable for penalties under section 6662 for 1989 and 1990.     The

issue remaining for decision as to Georgiou Retail Stores (GRS)

is whether GRS's cost of goods sold in 1989 must be reduced by

$130,181.

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.     The

Georgious were residents of California, and Kolonaki and GRS had

their principal places of business in California, at the time the

petitions were filed.

Kolonaki

     Georgiou incorporated Kolonaki in California in 1975 as a

retail store that sold giftware and clothing from various parts

of the world, predominantly merchandise from Greece.   Prior to

founding Kolonaki, Georgiou had obtained degrees in economics and

mathematics and had worked as a systems analyst.   Kolonaki was

wholly owned by Georgiou from incorporation throughout the years

in issue.   From 1975 through 1987, Kolonaki expanded to include

both wholesale and retail operations.   By 1988, the retail

division consisted of approximately 26 stores named "Georgiou".

The "Georgiou" stores' merchandise consisted primarily of
                                 - 4 -

clothing designed by Georgiou.    The wholesale division sold

merchandise to two other corporations, which then sold the goods

at retail.   The two other corporations were Naturelle

International, Inc., which was owned by Georgiou, and Alexia

Clothing, Inc. (Alexia), in which Georgiou was a minority

shareholder through 1988.   Alexia had a supply contract with

Kolonaki that required Alexia to purchase all of its merchandise

from Kolonaki.

     During 1988, Georgiou became interested in selling shares in

the retail division of Kolonaki to the public.    GRS was

incorporated on approximately September 23, 1988, in California

to take over Kolonaki's retail operations.    GRS acquired

Kolonaki's retail division pursuant to a two-part plan set forth

in a document titled "Agreement and Plan of Corporate Separation

and Reorganization" (the plan).    As the first part of the plan

required, Kolonaki transferred to GRS certain business assets and

liabilities associated with Kolonaki's retail clothing business.

The assets included all operating retail stores and the assets

associated with those stores.    The assets were transferred under

section 351, and the stock of GRS was issued in the name of

Kolonaki.

     The second part of the plan provided that the GRS stock

would be distributed to Georgiou as part of a tax-free corporate

separation and exchange pursuant to sections 355 and 368.    The

reorganization was subject to a condition precedent that required
                               - 5 -

the parties to obtain an opinion from tax counsel that the

transaction would qualify as a tax-free exchange.   Because the

parties never obtained an opinion, GRS remained a subsidiary of

Kolonaki.

     In 1988, Georgiou became interested in acquiring the assets

of Petite Concept, Ltd. (Petite), a corporation that operated a

chain of retail stores known as Karen Austin Petites.   The assets

consisted primarily of leases, leasehold improvements, and

property.   Petite had filed bankruptcy in November 1988.

Georgiou formed JAI to acquire certain assets of Petite.    JAI was

incorporated December 13, 1988, with Georgiou as the sole

shareholder.   Georgiou remained the sole record holder of JAI

stock from 1988 through the years in issue.   There were several

business reasons to form JAI including:    Kolonaki had just spun

off its retail division into GRS and adding a retail division

back to Kolonaki would have been counterproductive; GRS would be

a less desirable investment if it attempted to sell shares to the

public with a chain of bankrupt stores included in its assets;

and Georgiou did not want to provide either the Kolonaki or GRS

financial statements to the Petite lessors because several of the

lessors were also lessors of GRS stores.

     In December 1988, Petite agreed to sell to Georgiou or his

nominee the assets of 18 Petite stores.    Georgiou funded JAI with

$1,186,000 ($234,000 designated as capital and $952,000

designated as three loans).   JAI issued 23,400 shares of stock in
                                - 6 -

Georgiou's name in return for Georgiou's capital contribution.

JAI, as Georgiou's nominee, used the funds to purchase the Petite

assets from the bankruptcy trustee for $1,250,000.    As part of

the sale, Georgiou was required to guarantee personally eight of

the Petite retail leases that JAI purchased.    The value of the

eight leases with the guarantees was approximately $5.9 million.

Georgiou's liability under the guarantee continued whether the

leases were extended, modified, altered, or assigned and

irrespective of any bankruptcy, reorganization, or insolvency of

JAI.

       GRS and JAI were administered identically from their

inception.    Both purchased their merchandise wholesale from

Kolonaki, and they shared management personnel.    Georgiou

micromanaged the operations of Kolonaki, GRS, and JAI.     All

decisions, from clothing design to personnel, required his final

approval.

       In 1989, JAI, in addition to GRS, was being considered for a

public offering.    Ernst and Young was retained to perform certain

financial audits and prepare tax returns.    Ernst and Young

prepared tax returns for GRS and JAI for the year ended

September 30, 1989.    The GRS and JAI returns were prepared as

separate returns for submission to the Internal Revenue Service

(IRS).    GRS and JAI each filed a separate 1989 return.   The JAI

return listed Georgiou as the sole stockholder.    GRS was wholly

owned by Kolonaki.
                                 - 7 -

     The IRS began an audit of Kolonaki in November 1990.

Kolonaki's representative at the January 8, 1991, interview and

throughout the audit was David Pryor (Pryor), a C.P.A. with

Crisafi, Sciabica and Woodward (Crisafi), Georgiou's regular

accounting firm.    On March 7, 1991, the IRS began an audit of the

year ended September 30, 1989.    Early in the JAI audit, Pryor

informed the IRS agent that Georgiou was the owner of JAI.

     In April or May 1991, Georgiou met with Pryor and Robert

Woodward, two accountants from the Crisafi firm, to discuss

consolidated return treatment for JAI on Kolonaki's September 30,

1990, tax return.   Pryor had discovered the beneficial ownership

concept in a Bureau of National Affairs, Inc., tax portfolio and

presented it to Georgiou.   Pryor suggested that a second meeting

be held with Georgiou and Lucius P. Bernard (Bernard), Georgiou's

attorney, to discuss whether Kolonaki had beneficial ownership of

the JAI stock that was issued in Georgiou's name.

     Georgiou subsequently met with Pryor and Bernard to discuss

consolidated return treatment for JAI on Kolonaki's return.

Bernard was not a tax specialist.    The meeting concluded with the

understanding that JAI could file a consolidated return with

Kolonaki, if Kolonaki could establish that it was the beneficial

owner of at least 80 percent of JAI stock.    It was agreed that a

Holding Agreement between Kolonaki and Georgiou would be the best

way to document the intention that Kolonaki was the beneficial

owner of Georgiou's JAI stock.
                                - 8 -

     The conclusion of the meeting set in motion a number of

events.   Pryor returned to his accounting firm and made journal

entries in Kolonaki's books.    The entries reduced Georgiou's

liabilities to Kolonaki and replaced them with JAI liabilities to

Kolonaki.    The entries consisted of debits of $234,000 to

"Investment in Judy [JAI]" and $952,000 to "Accounts Receivable,

Judy [JAI]" (totaling $1,186,000) and of a credit of $1,186,000

to "Accounts Receivable, Georgiou".     The entries were dated "as

of 10/1/89" but were actually made sometime after the meeting in

1991.

     Entries were made in the JAI books to change notes payable.

The entries consisted of a $952,100 debit to "Notes Payable,

George Georgiou" and a $952,100 credit to "Notes Payable,

Kolonaki".    The entries were dated "as of September 30, 1990" on

the books but were actually made sometime after January 18, 1991.

     As part of the plan to sell shares to the public for JAI and

GRS, Ernst and Young prepared the September 30, 1990, tax returns

for the two corporations.    The GRS tax return was prepared pro

forma because Ernst and Young was aware that Georgiou planned to

have GRS file a consolidated return with Kolonaki.    The JAI tax

return was prepared as a separate return with Georgiou listed as

the sole stockholder.    Ernst and Young signed the JAI return on

June 12, 1991, and gave it to Crisafi.    Crisafi did not file with

the IRS the separate JAI tax return for 1990.
                               - 9 -

     Crisafi prepared Kolonaki's September 30, 1990, tax return.

The Kolonaki return claimed consolidated return treatment for JAI

and was filed and received by the IRS on June 19, 1991.   The

Kolonaki return was signed by the chief financial officer for

Kolonaki and stated:

     Kolonaki Imports, Inc. is the beneficial owner of Judy
     Alexander [JAI] pursuant to a holding agreement with
     George Georgiou, the holder of record and 100%
     shareholder of Kolonaki. The original 23,400 shares of
     Judy Alexander [JAI] were originally issued in January
     and March of 1989 pursuant to this agreement.

The Holding Agreement to which the tax return referred did not

exist at the time the return was filed.

     On August 6, 1991, a Holding Agreement was drafted to

substantiate Kolonaki's beneficial ownership of JAI.   The Holding

Agreement stated in part:

     WHEREAS, the parties intend, by this Agreement, to
     cause GEORGE GEORGIOU to own of record all of the
     issued and outstanding shares of Judy Alexander [JAI],
     and to hold said shares beneficially for and on behalf
     of KOLONAKI, and KOLONAKI intends to indemnify and hold
     GEORGE GEORGIOU harmless from any and all liabilities
     which he may incur or to which he may be subjected as
     the owner of said shares of stock.

The Holding Agreement began "This Agreement made this 15th day of

October, 1988" and ended "IN WITNESS WHEREOF, the parties have

caused these present to be executed the date and year first above

written."   Georgiou signed the document twice, once in his

capacity as president of Kolonaki and once in his individual

capacity.
                                - 10 -

        In 1991, a Supply Agreement existed between JAI and

Kolonaki.     The original agreement, dated March 1, 1989, and

signed by Georgiou, stated:     "RELATIONSHIP OF PARTIES.     JA [JAI]

and KOLONAKI are, for all purposes, independent parties."        A

September 12, 1991, transmittal letter from Pryor to Bernard

directed Bernard to revise the Supply Agreement between Kolonaki

and JAI (and Kolonaki and GRS).     The transmittal stated:    "Para.

13: relationship of parties.     Now: JA [JAI] and Kol [Kolonaki]

are for all purposes indep[endent] parties.     Change: JA is a

sub[sidiary] of Kol.     George has agreed to both."

        Revised Supply Agreements were forwarded from Bernard's firm

to Georgiou with a September 16, 1991, transmittal letter that

stated:     "Enclosed are revised Supply Agreements between Kolonaki

and JAI."     The changes to which Georgiou had agreed were in the

revised agreement that stated in part:     "RELATIONSHIP OF PARTIES.

* * *     The parties acknowledge that all outstanding shares in JA

[JAI] are held of record by GEORGE GEORGIOU under a Holding

Agreement for the benefit of KOLONAKI."     The revised Supply

Agreement was dated September 30, 1989, and was signed twice by

Georgiou, once as president for Kolonaki and once as president of

JAI.

       The Minutes of the First Meeting of the Board of Directors

of JAI were dated December 12, 1988.     Georgiou was named sole

director, president, secretary, and treasurer.     During that

meeting, it was resolved that 10,000 shares of corporate stock at
                              - 11 -

$10 per share would be issued to Georgiou pursuant to the

provisions of section 1244.   It was also resolved that the

corporation should borrow $400,000 from Georgiou and give him a

promissory note for that amount, payable on demand in 5 years,

with annual interest payments at the rate of 10 percent per

annum.

     The March 3, 1989, Minutes of a Special Meeting of the Board

of Directors of JAI resolved to issue an additional 13,400 shares

of section 1244 stock at $10 per share to Georgiou.   It was

resolved that the corporation should borrow $536,000 from

Georgiou and issue a promissory note in that amount, payable on

demand in 5 years, with annual interest payments at the rate of

10 percent per annum.

     The August 9, 1989, Minutes of a Special Meeting of the

Board of Directors of JAI resolved that the corporation should

borrow $16,100 from Georgiou and issue a promissory note in that

amount, payable on demand in 5 years, with annual interest

payments at a rate of 10 percent per annum.

     There were two sets of Minutes of Special Meeting of the

Board of Directors of JAI dated September 30, 1989.   The minutes

resolved to accept a Supply Agreement that required JAI to

purchase all of its merchandise from Kolonaki.   The original

minutes identified Kolonaki as "a California corporation".     The

September 30, 1989, minutes that were provided to the IRS agent

at audit, however, identified Kolonaki differently, stating that
                               - 12 -

there was a "Supply Agreement between this corporation [JAI] and

Kolonaki, this corporation's parent".

     In December 1989, Georgiou set up the George Georgiou Living

Trust and transferred personal assets into it.   Included in the

assets were 23,400 shares of JAI stock.   The September 15, 1990,

Minutes of the Regular Meeting of the Shareholder of JAI listed

as present at the meeting:   "GEORGE GEORGIOU, Trustee of the

George Georgiou Living Trust, Established December 5, 1989--

23,400 shares."

     The September 30, 1990, Meeting Minutes of the Board of

Directors of JAI that were given to the IRS agent during the

audit no longer named Georgiou as trustee of the JAI stock.

These minutes listed Georgiou as present and resolved:   "it would

be in the best interest of the corporation to elect to file

consolidated tax returns with KOLONAKI, a California corporation

which is the beneficial owner of all the issued and outstanding

shares of this corporation."

     Three sets of promissory notes from JAI to Georgiou were

prepared.   The notes represented the loans Georgiou made to JAI

as set forth in the JAI minutes.   The notes were for loans of

$400,000, $536,000, and $16,100.   The notes were dated 1988 and

1989.   Some of the notes contained an assignment clause that

stated:
                               - 13 -

                             ASSIGNMENT

          FOR VALUE RECEIVED, I hereby assign to KOLONAKI, a
     California corporation, all of my right, title and
     interest in and to the aforesaid promissory note dated
     December 12, 1988 made by JUDY ALEXANDER [JAI] and
     payable to GEORGE GEORGIOU in the principal amount of
     * * * [the loan amounts].

The assignment clauses were signed by Georgiou and dated either

September 30, 1989, or September 30, 1990.

     Bernard sent a letter to Georgiou dated April 16, 1991.

Enclosed with the letter were promissory notes for $400,000,

$532,000, and $16,100.   The letter stated:   "You must sign the

Notes * * *, and the Assignment Clause which is on the bottom of

each note * * *.   Make copies for your accountant to give to the

[IRS] auditor."

     In August 1991, Georgiou requested a written opinion from

Bernard regarding JAI's qualifications to file a consolidated

return with Kolonaki.    In response to the inquiry, Bernard sent

Georgiou a letter dated August 23, 1991, that stated:

     Since Kolonaki has the benefits of the ownership of all
     the shares in Judy Alexander [JAI], pursuant to the
     Holding Agreement dated October 15, 1988 between
     Kolonaki and George Georgiou, it seems obvious, without
     a formal opinion at this time, that the incidents and
     benefits of ownership of Judy Alexander [JAI] accrue to
     Kolonaki.

     Throughout 1991 and 1992, the IRS agent requested

information by issuing information document requests.    One

specific request was for documents that substantiated Kolonaki's

beneficial ownership of JAI.   In response to the requests, Pryor
                                - 14 -

gave the agent the backdated Holding Agreement, Supply Agreement,

minutes, and promissory notes.

     In a letter dated December 13, 1991, Bernard informed Pryor

that Bernard just became aware of the October 15, 1988, date on

the Holding Agreement.   The letter stated:

     I discovered, to my chagrin, that the Holding Agreement
     contains an obvious error which, if not called to the
     attention of the person to whom it was delivered, could
     be misleading.

            *      *     *      *        *   *       *

     As you know, the Holding Agreement was, in fact,
     drafted on August 6, 1991 to memorialize the
     understanding which Mr. Georgiou and Kolonaki had
     reached in October 1988. * * *

Bernard stated in the letter that the inaccurate date was a

typographical error that was the result of "boilerplate" language

on his computer.   Bernard asked Pryor to forward the information

about the error to the agent.

     The agent also requested information from Ernst and Young

regarding Kolonaki's beneficial ownership.       In a letter dated

February 13, 1992, Ernst and Young informed the agent:       "We first

learned in writing of the holding agreement upon receipt of the

client representation letter dated September 24, 1991, for the

1990 fiscal year."

     Respondent disallowed the JAI loss that was deducted by

Kolonaki on Kolonaki's 1990 Form 1120 tax return.
                             - 15 -

Georgiou

     In 1980, Kolonaki extended a line of credit of $500,000 to

Georgiou, its sole shareholder.   The credit limit was

subsequently increased as follows:

    Date                          Amount of Credit Limit
Feb. 15, 1980                           $   500,000
Feb. 15, 1982                            1,000,000
Feb. 17, 1984                            1,500,000
Feb. 14, 1986                            2,000,000
June 30, 1988                            3,000,000
June 30, 1989                            5,000,000



     During the years in issue, transactions reflected in

Kolonaki's Account 121--Loan to Shareholder can be summarized as

follows:
                                 - 16 -

    Year Ended:         Sept. 30, 1989        Sept. 30, 1990

Beginning Balance        $    757,530           $1,082,602
Advances to Georgiou          857,360            2,608,562
Repayments                   (532,000)1         (1,700,909)2
                                        3                    3
Ending Balance           $1,082,602             $1,990,256


     1
      The 1989 repayments consisted of one check for $325,000
dated 9/3/89 and a journal entry of $207,000 that represented an
offset of rents that Kolonaki owed Georgiou on the rental of a
building owned by Georgiou (the amount was reported on Georgiou's
Form 1040).
     2
      The 1990 repayments consisted of three journal entries:
$1,186,000 "to record investment in Judy Alexander [JAI] as of
10/1/89 for consolidation purposes" (the entry was actually made
in April or May 1991); $312,161 "to record Kolonaki loan to
Alexia as of 10/1/89"; and $115,000 that stated "George paid the
monies to Alexia for Kolonaki's purchase."
     3
      The errors in calculations are from Kolonaki's journal and
from rounding.

     No promissory notes were executed for the advances from

Kolonaki's Account 121--Loan to Shareholder from 1980 through the

years in issue.   No maturity date was set for repayment of the

advances.    Georgiou did not pledge any collateral as security for

the repayment of the advances from 1980 through 1990.    Kolonaki

did not take any action to enforce the repayment of the amounts

advanced to Georgiou.   However, a March 28, 1991, letter from

Bernard to Georgiou stated:

          Enclosed please find an original and one copy each
     of Security Agreement, Consent by Directors to
     Corporation Action dated June 30, 1988 and Consent by
     Directors to Corporate Action dated June 30, 1989.
                                - 17 -

     * * * Please sign the originals and return them to me
     for inclusion in the corporate record book. * * *

     The enclosed Security Agreement was dated February 15, 1980,

and gave Kolonaki "a present security interest in collateral

described as all of the personal property * * * of DEBTOR

[Georgiou], * * * to secure * * * advances under a certain line

of credit".   The Consent by Directors document dated 1988

resolved that all advances made under the line of credit to

Georgiou shall bear interest at the rate of 10 percent per annum.

Interest only payments were due annually, with all unpaid

principal due December 31, 1995.

     During 1989 and 1990, Kolonaki paid Georgiou a salary of

$144,000 and $225,641, respectively.     The Georgious' 1989 and

1990 Form 1040 tax returns show adjusted gross income of $218,281

for 1989 and $283,987 for 1990.     Georgiou stated that he believed

the salary he received from Kolonaki was very low.

     During 1989 and 1990, Kolonaki had taxable income and

retained earnings as follows:

Year Ended

Sept. 30             Taxable Income        Retained Earnings

  1989                 $1,149,333             $2,391,725
  1990                  1,032,955              2,424,499

Kolonaki did not pay dividends for either 1989 or 1990.     Kolonaki

has never paid dividends for any year since its incorporation.
                               - 18 -

      Georgiou claimed a $100,000 home interest deduction on his

1990 Form 1040 tax return for a portion of the advances that was

allegedly used to remodel his private residence.

      Respondent determined that Georgiou's withdrawals from

Kolonaki's line of credit were constructive dividends and not

loans.    Respondent further determined that there was no allowable

interest expense because the advances were not loans.

GRS

      The GRS 1989 Form 1120 tax return represented the value of

inventory at the beginning of the year as $935,181.   The GRS

beginning inventory was transferred from Kolonaki to GRS pursuant

to a section 351 exchange for GRS stock.   The Kolonaki books

reflected the transfer of opening inventory to GRS.   The basis of

the transferred inventory as it appeared on the Kolonaki books

was $805,000.

      Respondent reduced the value of opening inventory that GRS

represented on its 1989 tax return from $935,181 to $805,000.

Respondent maintains that the proper value is the transferor's

basis in the property transferred.

                               OPINION

      Kolonaki, Georgiou, and GRS have the burden of proof on all

issues.    Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); Rockwell v. Commissioner, 512 F.2d 882 (9th Cir.

1975), affg. T.C. Memo. 1972-133.
                               - 19 -

I.   Kolonaki

      Kolonaki asserts that it was the beneficial owner of JAI

stock and was entitled to deduct a $1,580,458 net loss from JAI

on its 1990 Form 1120 tax return.    Respondent contends that

Kolonaki was not the beneficial owner of JAI stock and,

therefore, not entitled to include JAI on its consolidated

return.    Respondent acknowledges that beneficial ownership would

satisfy the ownership requirement of section 1504(a).    Respondent

argues, however, that there was no credible documentation to

substantiate Kolonaki's beneficial ownership of JAI, only

documents that were created or altered and backdated after the

audits began.

      Kolonaki's right to file a consolidated return depends on

whether, during the year in issue, Kolonaki "owned directly",

within the meaning of section 1504, at least 80 percent of the

voting power of all classes of JAI stock.    Under section 1501, an

affiliated group has the privilege of making a consolidated

return.    An affiliated group is defined in section 1504(a) as

follows:

           (a) Affiliated Group Defined.--For purposes of
      this subtitle--

                 (1) In general.--The term "affiliated group"
            means--

                      (A) 1 or more chains of includible
                 corporations connected through stock
                 ownership with a common parent corporation
                              - 20 -

                which is an includible corporation, but only
                if--

                     (B)(i) the common parent owns directly
                stock meeting the requirements of paragraph
                (2) in at least 1 of the other includible
                corporations, and

                        (ii) stock meeting the requirements
                of paragraph (2) in each of the includible
                corporations (except the common parent) is
                owned directly by 1 or more of the other
                includible corporations.

               (2) 80-percent voting and value test.--The
          ownership of stock of any corporation meets the
          requirements of this paragraph if it--

                     (A) possesses at least 80 percent of the
                total voting power of the stock of such
                corporation, and

                     (B) has a value equal to at least
                80 percent of the total value of the stock of
                such corporation.

     The parties stipulated that Georgiou was the record owner of

100 percent of JAI stock.   However, the "direct" ownership

requirement in section 1504(a) is not synonymous with legal or

record ownership.   See Miami National Bank v. Commissioner, 67

T.C. 793 (1977).

     "Direct" is not used to restrict ownership to those

situations in which the corporation has legal title to the stock.

Corporations that are in effect one business unit because of

their actual ownership have been allowed to file a consolidated

return, regardless of who is the record owner of the stock.     Id.

at 798-799.   See Lavenstein Corp. v. Commissioner, 25 F.2d 375,
                                - 21 -

376 (4th Cir. 1928), revg. 6 B.T.A. 1134 (1927); Macon, Dublin &

Savannah R.R. Co. v. Commissioner, 40 B.T.A. 1266, 1273 (1939);

Eastern Util. Inv. Corp. v. Commissioner, 38 B.T.A. 778, 788

(1938).    If consolidation depended solely on legal or record

ownership, corporations with no real common ownership or economic

relationship could consolidate their income and deductions, in

violation of the statutory purpose.      See Lavenstein Corp. v.

Commissioner, supra at 377; Macon, Dublin & Savannah R.R. Co. v.

Commissioner, supra at 1273.    This Court has thus held that the

ownership referred to in section 1504(a) is beneficial ownership,

regardless of the arrangement by which it is created.      Miami

National Bank v. Commissioner, supra at 801; see INI, Inc. v.

Commissioner, T.C. Memo. 1995-112.

     The issue here turns on whether Kolonaki was the beneficial

owner of JAI stock.    To determine whether Kolonaki had beneficial

ownership of JAI stock, we must look to the legal documents that

were executed and the rights created thereby.      Miami National

Bank v. Commissioner, supra at 800.      Additionally, in carrying

out this task, we look to the intent and agreement of the

parties.   Id. at 803.   Because courts cannot successfully

conjecture as to the subjective intent of the parties, the

objective evidence of intent provided by the parties' overt acts

must be relied upon.     Ragghianti v. Commissioner, 71 T.C. 346,

350 (1978) (citing Pacific Coast Music Jobbers, Inc. v.
                              - 22 -

Commissioner, 55 T.C. 866, 874 (1971), affd. 457 F.2d 1165 (5th

Cir. 1972)), affd. without published opinion 652 F.2d 65 (9th

Cir. 1981).

     Kolonaki relies primarily on Georgiou's assertion that

Georgiou, as Kolonaki's sole shareholder, always intended

Kolonaki to be the beneficial owner of the JAI stock.    Kolonaki's

reliance on Georgiou's subjective intent is misplaced.     A

corporation and its sole shareholder are separate legal entities

if a business purpose exists for the corporation.   Moline

Properties v. Commissioner, 319 U.S. 436, 438-439 (1943).

          The doctrine of corporate entity fills a useful
     purpose in business life. Whether the purpose be to
     gain an advantage under the law of the state of
     incorporation or to avoid or to comply with the demands
     of creditors or to serve the creator's personal or
     undisclosed convenience, so long as that purpose is the
     equivalent of business activity or is followed by the
     carrying on of business by the corporation, the
     corporation remains a separate taxable entity. * * *
     [Id.; fn. ref. omitted.]

The degree of corporate purpose and activity requiring

recognition of the corporation as a separate business entity is

extremely low.   Strong v. Commissioner, 66 T.C. 12, 24 (1976),

affd. without published opinion 553 F.2d 94 (2d Cir. 1977).

Kolonaki carried on business activity.   It entered into

contracts, such as the Supply Agreement with Alexia.    Kolonaki

owned the GRS stock and filed its own corporate tax returns.

Kolonaki's business activities, separate from Georgiou's personal

affairs, are sufficient evidence of Kolonaki's status as a
                                - 23 -

separate legal entity from Georgiou.     "The fact is that * * *

[the taxpayer] did have a separate legal existence with

privileges and obligations entirely separate from those of its

stockholders.    The fact that it had only one stockholder seems of

no legal significance."     Burnet v. Commonwealth Improvement Co.,

287 U.S. 415, 419 (1932).

     The analysis in Moline Properties can also be applied to

distinguish Georgiou and JAI as separate legal entities.

Georgiou evaluated the purchase of Petite in his individual

capacity.   He decided to incorporate JAI based on several

business reasons, including Georgiou's desire to withhold

Kolonaki's financial information from lessors of Petite stores

and because Kolonaki had just divested itself of its retail

division creating GRS.    Georgiou's business reasons for forming

JAI and its subsequent business activity establish JAI as a

separate legal entity from Georgiou.     See Moline Properties v.

Commissioner, supra at 438.

     The consequence of the separate legal status of Kolonaki,

Georgiou, and JAI is that their overt acts must be analyzed

independently.    Kolonaki asserts that it was the beneficial owner

of JAI stock even though it was not the record owner.     We agree

that record ownership is not necessary to satisfy the "directly

owned" requirement in section 1504(a).     The cases where courts

have permitted a division of legal and beneficial ownership,
                              - 24 -

however, typically involve facts (1) where the legal and

beneficial owner divests itself of legal ownership and retains

the beneficial ownership for a legitimate business reason (see

Miami National Bank v. Commissioner, supra; Macon, Dublin &

Savannah R.R. Co. v. Commissioner, supra) or (2) where an entity

creates another to act as its agent to acquire legal title, while

vesting beneficial ownership in itself (see Commissioner v.

Bollinger, 485 U.S. 340 (1988)).

     Kolonaki relies on Miami National Bank and Macon, Dublin &

Savannah R.R. Co. to support its assertion of beneficial

ownership.   These cases are distinguishable on the facts.    In

Miami National Bank, a corporation retained beneficial ownership

when it transferred record title of shares of stock to a

subordinated securities account.   The corporation retained

substantial rights under the agreement, including the right to

dividends, right to vote the stock, and right to withdraw the

stock if other readily marketable securities of equivalent value

were substituted.

     In Macon, Dublin & Savannah R.R. Co., a corporation

transferred record title of the stock of its subsidiary to a

nominee while retaining beneficial ownership.   The nominee

agreement stated that the corporation was entitled to all rights

and privileges incident to the stock and had the option to
                                - 25 -

repurchase the stock.   Both parties understood that the

transferee was acting as a nominee.

     In contrast to the foregoing cases, here Kolonaki never held

record title to JAI stock.   JAI stock was originally issued in

Georgiou's name, when Georgiou made the capital contributions to

JAI, and the stock has remained in Georgiou's name through the

years in issue.   No contemporaneous agreement was created between

Kolonaki and Georgiou that set forth the beneficial ownership

arrangement and the parties' rights.

     Kolonaki also relies on Bollinger to establish beneficial

ownership.   In Bollinger, the Court sought to determine whether

an agency relationship existed between the record owner and the

beneficial owner of property.    The Supreme Court held that a

corporation that was formed to avoid Kentucky usury laws was an

agent for the partnership and stated in part:

     It seems to us that the genuineness of the agency
     relationship is adequately assured, and tax-avoiding
     manipulation adequately avoided, when the fact that the
     corporation is acting as agent for its shareholders
     with respect to a particular asset is set forth in a
     written agreement at the time the asset is acquired,
     the corporation functions as agent and not principal
     with respect to the asset for all purposes, and the
     corporation is held out as the agent and not the
     principal in all dealings with third parties relating
     to the asset. * * * [Commissioner v. Bollinger, supra
     at 349-350.]

     In the instant cases, there was no credible evidence of an

agreement, written or otherwise, that established that Georgiou

acted as Kolonaki's agent when Georgiou formed JAI.    Georgiou
                               - 26 -

provided the funds to capitalize JAI and to finance the purchase

of Petite.    Georgiou held himself out as the principal in

dealings with third parties, such as when Georgiou purchased

Petite using JAI as his nominee.    Georgiou transferred the JAI

stock into his living trust and signed the trust document.     The

minutes of the JAI board of directors meetings reflect that it

was Georgiou, not Kolonaki, who ran the operations of JAI and

made business decisions.    The facts here are easily

distinguishable from Bollinger, where "In every case, * * *

[third parties] were aware that the corporation was acting as

agent of the partnership in holding record title."      Id. at 343-

344.

       Kolonaki provided documents to the IRS agent in an attempt

to substantiate Kolonaki's beneficial ownership of JAI.     The

documents consisted of a Holding Agreement, a Supply Agreement,

promissory notes with assignments, and minutes of JAI and

Kolonaki board meetings.    The dates on the documents ranged from

1988 through 1990.    These documents do not establish beneficial

ownership during 1990 because the documents were either created

or altered in 1991 and were backdated.

       In INI, Inc. v. Commissioner, T.C. Memo. 1995-112, a

corporation and its wholly owned subsidiary attempted to separate

by executing legal documents and transferring assets and

liabilities.    The corporation and its subsidiary had filed
                               - 27 -

consolidated returns in the past and presented irrevocable

proxies and an agreement dated September 30, 1988, as evidence of

an earlier separation.   INI, Inc., alleged that the agreement and

proxies were backdated and therefore did not take effect until

after September 30, 1988.   This Court stated in part:   "In the

event that we were to determine that the execution of the

irrevocable proxies occurred sometime after September 30, 1988,

it would then become necessary for us to determine when the

Agreement became effective and whether it was sufficient to

deconsolidate the entities."   Id.   Here we conclude that the

contemporaneous documents belie any claim that the backdated

documents memorialize the actual agreement at the earlier and

crucial date.   See Saigh v. Commissioner, 36 T.C. 395, 420

(1961).

     On brief, Kolonaki argues that it has beneficial ownership

of JAI stock because JAI and Kolonaki are effectively one

business unit, administered as one company with Georgiou as the

head of the economic entity.   A similar argument was rejected in

Ray Engineering Co. v. Commissioner, 42 T.C. 1120 (1964), affd.

347 F.2d 716 (3d Cir. 1965).   In Ray Engineering Co., the

taxpayer filed consolidated returns based on operation of the two

corporations as a business unit with the same executive officer

who owned all of the stock in both corporations.   The Court held

that there was "no common parent" within the meaning of section
                                - 28 -

1504 of the 1954 Code [1504(a) of the 1986 Code] and stated in

part:

      Since neither * * * [the taxpayer] nor Branch was
      connected through stock ownership with a common parent,
      the basic requirement of section 1504 has not been met.
      * * * [The taxpayer] and Branch were not members of an
      affiliated group under section 1504 and therefore were
      not entitled to file a consolidated return under
      section 1501. * * * [Id. at 1122.]

For the same reason, we reject Kolonaki's argument here.

        In sum, Kolonaki is a separate legal entity from Georgiou

and JAI.     Kolonaki never held record title to JAI stock, and

Georgiou was not Kolonaki's agent.       Kolonaki did not present any

credible documentation that would substantiate Kolonaki's

beneficial ownership of JAI stock as of the controlling date.       We

conclude, therefore, that Kolonaki did not have beneficial

ownership of JAI stock as required by the "directly owned"

provision in section 1504(a).     We sustain respondent's

determination that Kolonaki is not entitled to file a

consolidated return with JAI; therefore, Kolonaki cannot deduct a

loss from JAI on its 1990 tax return.

II.     Georgiou

        Georgiou asserts that the advances from Kolonaki's Account

121--Loan to Shareholder were nontaxable loans that he intended

to repay.     Respondent contends that the advances were taxable

distributions, i.e., dividends, that were includable in

Georgiou's taxable income.     Respondent argues that, at the time
                                - 29 -

the funds were transferred, there was no intent to repay the

advances because there was no fixed time and plan for repayment;

no maturity date; no ceiling placed on the advances; no

promissory notes; and the documentation provided at audit

consisted of backdated corporate minutes, a backdated security

agreement, backdated promissory notes, and changed accounting

records.

       Georgiou further asserts that he is entitled to a $76,605

business interest deduction in relation to the advances.

Respondent contends that there is no allowable interest deduction

because the advances are not loans.

       Whether advances from a corporation to its shareholder

constitute bona fide loans is a factual question and depends on

the existence, at the time the advances occurred, of an intent on

the shareholder's part to repay the advances and an intent on the

corporation's part to enforce the obligations.    Berthold v.

Commissioner, 404 F.2d 119, 122 (6th Cir. 1968), affg. T.C. Memo.

1967-102.    As the state of a taxpayer's mind at a given time in

the past is not directly ascertainable, we must consider

objective evidence.    See Baird v. Commissioner, T.C. Memo. 1982-

220.    The issue thus turns upon all of the circumstances

surrounding the transactions.    Wiese v. Commissioner, 93 F.2d 921

(8th Cir. 1938), affg. 35 B.T.A. 701 (1937).    Where the

shareholder receiving the advances controls the corporation,
                              - 30 -

however, we must carefully scrutinize the transactions.     Haber v.

Commissioner, 52 T.C. 255, 266 (1969), affd. per curiam 422 F.2d

198 (5th Cir. 1970).

     In determining whether the shareholder and the corporation

each possessed the requisite intent at the time of the advances,

the courts have examined a number of factors, including the

following:   The existence of a fixed time and plan for repayment;

whether a ceiling was placed on advances; whether there was

accrual and payment of interest; whether the loans were recorded

on the corporate books; if there has been a failure to repay a

mounting loan balance; who had control over the decision to

enforce the obligation; whether debt instruments were executed;

the existence of earnings and profits; whether dividends were

paid; whether there is corroborated, credible testimony of the

taxpayer; the salary received by the shareholder; and the

shareholder's ability to repay.   See, e.g., Berthold v.

Commissioner, supra at 121; Wiese v. Commissioner, supra at 923;

Baird v. Commissioner, 25 T.C. 387 (1955); Baird v. Commissioner,

T.C. Memo. 1982-220.

     Because of the nature of this issue, the above factors are

not exclusive, and no one factor is determinative.   The factors

merely represent objective evidence helpful to the courts in

analyzing all of the relevant facts and circumstances.
                               - 31 -

     Georgiou relies most heavily upon the books and records of

Kolonaki and upon purported loan repayments as evidence of his

intention to repay the advances.   Georgiou refers to two

documents to support his position:      The Security Agreement, dated

1980, which gave Kolonaki a present security interest in

Georgiou's personal assets, and the Consent by Directors

document, dated 1988, which established a maturity date and

interest rate for the advances.

     Prior to the creation of the Consent by Directors document,

there was no interest rate and no interest accrued on the

advances.    Both of these documents, however, were created in 1991

and backdated.   This Court's analysis in Saigh v. Commissioner,

36 T.C. at 420, provides an appropriate response to Georgiou's

arguments:

          [Taxpayers] argue that actions taken subsequent to
     the date of transfer, when combined with the original
     event, clearly establish the real intention of the
     parties. They rely upon the confirmation of the loan
     by the directors of Building Inc. and Investment and
     the execution and acceptance of the note. This action
     was not undertaken until 2 months after the transaction
     in issue occurred. No explanation is given of why
     nothing was done or said at the July 25, 1946, meeting.
     While the confirmation and note would ordinarily be
     some evidence, other facts present in the record
     destroy their probative value. The actions taken were
     tardy, and undertaken only after reflection and a shift
     in opinion. [Taxpayers] would overlook the
     interlocking control between Investment and Building
     Inc. What was done was not the act of independent
     directors, i.e., it was not the result of bargaining
     between parties, each looking after his own self
     interest. Saigh acted on both sides and, indeed,
                                - 32 -

     guided and engineered the entire transaction step by
     step.

     In Baird v. Commissioner, 25 T.C. at 394-395, we reached a

similar conclusion:

          Nor do we regard the giving of demand notes dated
     February 2, 1953, to Baird & Company * * * of any
     significance as indicating that [taxpayer's]
     withdrawals constituted debts, since this was done only
     after the revenue agent took the position that the
     "loans" were in fact disguised dividends. To us, it is
     incredible that the Baird brothers would have waited
     more than 6 years to execute a note for the $17,540 if
     they had intended to do so in the first place. It
     seems obvious that the execution of the notes was a
     mere afterthought directed to an effort to give the
     withdrawals a character which they did not have during
     the years when they were made. * * *

     Accordingly, the backdated documents that provide an

interest rate and maturity date will be given little weight in

our determination because they were created after the years in

issue and substantially later than the actual advances.     "The

determinative fact is the intention as it existed at the time of

the transaction.    This intention cannot be vitiated by changed

circumstances or subsequent action bred in the cold light of tax

consequences."     Saigh v. Commissioner, supra at 420.

     Georgiou's repayments of advances consisted primarily of

adjustments to journal entries.    Total advances for 1989 and 1990

were $857,360 and $2,608,562, respectively.    The 1989 repayments

consisted of a check for $325,000 and a journal entry.    All of

the 1990 repayments were journal entries made in 1991 in an

attempt to reduce the balance of the Loan to Shareholder account.
                              - 33 -

In Baird, this Court also addressed the issue of journal entries

as payments and stated:

     Separate treatment of the joint accounts on the books
     is not sufficient to support a contrary view in the
     light of all the surrounding circumstances, and the
     $17,540 debit from the cash journal to "Notes
     Receivable" account was simply a shift from one account
     to another. There is nothing here to indicate a plan
     or intention to repay, and the conduct of the parties
     over a period of years supports a contrary view.
     [Baird v. Commissioner, 25 T.C. at 394.]

     Disregarding the repayments that consisted of journal

entries made in 1991, the repayments are insubstantial in

relation to the advances.   Failure to repay an ever mounting loan

balance points to constructive dividends.   See Baird v.

Commissioner, T.C. Memo. 1982-220.

     Georgiou also relies on the treatment of the advances on the

books and tax returns of Kolonaki to establish that the advances

were loans.   Kolonaki recorded the advances in the Loan to

Shareholder account.   Although the treatment of the advances is

an important factor to consider, it must be considered in

relation to the other facts that would indicate a loan.

     While it is true that the absence of the notes and the
     failure to charge or pay interest are not alone
     conclusive on the basic issue, it is equally true that
     the treatment of * * * [the taxpayers'] withdrawals on
     the corporate books as "Notes Receivable" is not
     controlling, since it is well settled that book entries
     may not be used to conceal realities as a means of
     relieving the taxpayer from liability for income taxes.
     * * * [Baird v. Commissioner, 25 T.C. at 395.]
                                  - 34 -

       On brief, Georgiou asserts that his annual income of

$1 million is evidence of his ability to repay the debt.       This

assertion contradicts Georgiou's Form 1040 tax returns for 1989

and 1990 that report adjusted gross income of $218,281 and

$283,987, respectively.    Where a sole shareholder receives no

salary from a corporation, other disbursements, represented as

"loans", may in reality constitute salary substitutes.       Receipt

of salaries denominated as such, on the other hand, may support

the characterization of other disbursements as loans.       See Baird

v. Commissioner, T.C. Memo. 1982-220.       Although Georgiou received

a salary from Kolonaki, he testified that the salary was very

low.    The low salary would have been Georgiou's only remuneration

from Kolonaki, because Kolonaki never paid dividends, despite

substantial earnings and profits in both 1989 and 1990.       A

history of failure to pay dividends in the face of earnings and

profits available for that purpose tends to show that "loans" are

camouflaged dividends.     Id.

       Georgiou's final argument, i.e., that the advances were

loans because there were ceilings placed on the amount of the

advances, is unpersuasive.       The line of credit that Kolonaki

extended to Georgiou increased approximately every 2 years.         It

was Georgiou, as the sole shareholder of Kolonaki, who had the

authority to increase the line of credit.       Similarly, it was

Georgiou, as the sole shareholder, who had the authority to

enforce the obligations.    Courts strictly scrutinize transactions
                              - 35 -

between a corporation and its sole shareholder.   That the

shareholder, in effect, has the sole authority to enforce the

debt against himself certainly raises questions about the

substantive significance of formal debt instruments and book

entries.   Saigh v. Commissioner, supra at 420.

     The record herein contains little or no reliable evidence in

support of Georgiou's position.   Kolonaki classified the advances

as loans on its books and records, and Georgiou made a small

repayment during the years in issue.   These factors are

outweighed by the absence of credible documents that would

substantiate Georgiou's intent to repay the advances at the time

the advances were made.   The backdated documents that reflect a

security agreement, maturity date, and an interest rate for the

advances are not reliable.   The ceiling on the advances and the

right to enforce the obligations are illusory because Georgiou,

himself, controlled these decisions.

     Noticeably absent are promissory notes.   A taxpayer's

execution and delivery to the corporation of promissory notes or

other debt instruments in connection with, and in close temporal

proximity to, the corporate disbursements is evidence that they

are loans.   See Baird v. Commissioner, T.C. Memo. 1982-220.    No

promissory notes were executed for the advances from the Loan to

Shareholder account from 1980 through the years in issue.

     After considering the factors that distinguish loans from

dividends, we conclude that Georgiou has failed to satisfy his
                                 - 36 -

burden of proof on this issue.     Therefore, we sustain

respondent's determination that the advances to Georgiou from

Kolonaki were constructive dividends and not loans.     Accordingly,

respondent's determination that there is no allowable business

interest deduction on the advances is also sustained.

       Because we have concluded that Georgiou did not transfer JAI

stock to Kolonaki during the years in issue, we need not consider

whether Georgiou would have received a section 304 dividend as a

result of such a transfer.

III.    GRS

       GRS contends that the value of its 1989 opening inventory

was $935,181.     GRS reached this conclusion based on a lengthy

analysis of fair market value.     Respondent contends that the

correct valuation is determined by sections 351(g)(2) and 362(a).

       GRS obtained its 1989 opening inventory from Kolonaki.      When

Kolonaki divested itself of its retail division, Kolonaki

transferred assets, including inventory, to GRS in exchange for

GRS stock.     The exchange was treated as a section 351 exchange.

Section 351(g) refers to section 362(a), which sets forth the

basis of the transferred assets:

       SEC. 362 BASIS TO CORPORATIONS.

            (a) Property Acquired by Issuance of Stock or as
       Paid-In Surplus.--If property was acquired on or after
       June 22, 1954, by a corporation--

                   (1) in connection with a transaction to which
              section 351 (relating to transfer of property to
              corporation controlled by transferor) applies, or
                               - 37 -

                (2) as paid-in surplus or as a contribution
           to capital,

      then the basis shall be the same as it would be in the
      hands of the transferor, increased in the amount of
      gain recognized to the transferor on such transfer.

The applicability of section 351 to the Kolonaki/GRS exchange is

not in controversy.   Similarly, it is not disputed that Kolonaki

controlled GRS after the exchange as required by section 362.

The use of fair market value by GRS to determine the basis of the

assets is inappropriate.    The present facts fit squarely within

the language of the Code.    Therefore, we sustain respondent's

determination that the value of the opening inventory of GRS is

equal to the basis of the inventory in the hands of the

transferor.

IV.   Additions to Tax and Penalties

      Section 6653(a)(1) imposes an addition to tax in an amount

equal to 5 percent of the underpayment if any part of the

underpayment is due to negligence or disregard of rules or

regulations.    Section 6661 imposes an addition to tax in an

amount equal to 25 percent of the underpayment if the

underpayment is attributable to a substantial understatement.

Both sections 6653(a)(1) and 6661 apply to tax returns with a due

date prior to December 31, 1989.    The sections were repealed

December 31, 1989, with the current sections both recodified in

section 6662, effective for returns with a due date after

December 31, 1989.    Kolonaki and JAI had a fiscal year ending

September 30.    The Georgious were calendar year taxpayers.
                               - 38 -

       Section 6662(a) imposes a penalty for the underpayment of

tax in an amount equal to 20 percent of the underpayment if the

underpayment is attributable to negligence or disregard of rules

or regulations or to any substantial understatement of income

tax.

       "Negligence", as used in section 6653(a)(1), is defined as

the "lack of due care or failure to do what a reasonable and

ordinarily prudent person would do under the circumstances."

Neely v. Commissioner, 85 T.C. 934, 947 (1985).    Negligence

includes any failure to make a reasonable attempt to comply with

the provisions of the internal revenue laws or to exercise

ordinary and reasonable care in the preparation of a tax return,

including any failure by the taxpayer to keep adequate books and

records or to substantiate items properly.    Secs. 6653(a)(3),

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.    "Disregard"

includes any careless, reckless, or intentional disregard of

rules or regulations.    Secs. 6653(a)(3), 6662(c); sec, 1.6662-

3(b)(2), Income Tax Regs.

       For purposes of sections 6661 and 6662(a), an understatement

is substantial if it exceeds the greater of 10 percent of the

correct tax or $5,000 or, in the case of a corporate taxpayer,

$10,000.    Secs. 6661(b)(1)(A) and (B), 6662(d)(1)(A) and (B).

Where an item is not attributable to a tax shelter, the

understatement may be reduced by the portion attributable to such

item and the addition to tax accordingly reduced if the
                              - 39 -

taxpayer's treatment of the item was based on substantial

authority or was adequately disclosed in the return or in a

statement attached to the return.    Secs. 6661(b)(2)(B)(i) and

(ii), 6662(d)(2)(B)(i) and (ii).    The term "understatement" is

defined as the excess of the amount of tax required to be shown

on the return for the taxable year over the amount of tax shown

on the return for the taxable year, reduced by any rebate.     Secs.

6661(b)(2), 6662(d)(2)(A).

A.   Section 6662 Penalty

      Respondent determined that the section 6662 accuracy-related

penalty for Georgiou and Kolonaki was based on a substantial

understatement or, in the alternative, negligence.     Both carry

the same penalty.   Kolonaki and Georgiou (petitioners) argue that

an accuracy-related penalty should not be imposed.

      Petitioners rely on section 6664(c), which states that 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 and that the taxpayer acted in

good faith with respect to that portion.    Petitioners contend

that they are not liable for the penalty because they reasonably

and in good faith relied upon the advice of professionals,

specifically, Pryor and Bernard.    But reliance on the advice of a

professional does not necessarily demonstrate reasonable cause

and good faith.   Sec. 1.6664-4(b), Income Tax Regs.    "Reliance on

professional advice, standing alone, is not an absolute defense
                              - 40 -

to negligence, but rather a factor to be considered.   First it

must be established that the reliance was reasonable."   Freytag

v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011

(5th Cir. 1990), affd. 501 U.S. 868 (1991).

     Respondent maintains that petitioners may not rely on the

advice of Bernard and Pryor for protection from the penalty.

Respondent argues that petitioners, Bernard, and Pryor conspired

to prepare and present to the IRS backdated documents and

accounting entries.   We agree with respondent.

     Petitioners "instructed" Pryor and Bernard rather than

relied on them.   Bernard testified:

          If I had to describe myself in connection with all
     of my activities for Mr. Georgiou, if I had to draw the
     distinction between scrivener and business adviser, I
     would describe myself as a scrivener. I would produce
     documents to reflect agreements that had been reached
     by the client.

Bernard stated that he had not seen the financial records or tax

returns of petitioners' corporations and that he would

"absolutely not" describe himself as Georgiou's or Kolonaki's tax

adviser.   Regarding Kolonaki, Bernard testified as follows:

          Q Did you feel it was necessary in your role as
     counsel, business counsel, to know something about the
     finances of the corporate client?

          A Not only didn't I, because I wasn't giving
     Mr. Georgiou financial advice, but I felt that if I had
     inquired about financial information about Kolonaki I
     would have been rebuffed and it would have damaged my
     relationship with the client.
                             - 41 -

Additionally, assuming petitioners relied on counsel to provide

them with advice, petitioners disregarded the advice.   With

respect to the advances, Bernard testified:

          Q Did you advise Mr. Georgiou at any time with
     respect to whether or not he should prepare promissory
     notes?

          A   Yes.

          Q Or whether it was a good idea to prepare
     promissory notes?

          A Yes, of course. Again, as a routine I advise
     clients that they must--they should treat their
     corporations as separate entities and not just another
     side of their trouser pocket, that any time money flows
     from the corporation to them it has consequences. And
     if it's a loan, it needs to be reflected by a
     promissory note. It's always better if it's secured.
     And the note must be for a reasonable period of time
     and must require payments.

Pryor testified on the consolidated return issue as follows:

          Q And how did you know to focus on the issue of
     beneficial ownership?

          A * * * I looked up in a source we have called
     the Bureau of National Affairs, it's a tax service, and
     what the criteria is for filing a consolidated return.
     I think up to that point [spring 1991] I have been
     informed that George was the owner of Judy Alexander
     [JAI].

          And I think in that meeting, I said, Well, we
     cannot file a consolidated return unless we can show
     that there's beneficial ownership between Kolonaki and
     JAI Alexander. Even though someone is the nominal
     owner, if we can show beneficial ownership, then it
     would be possible to file a consolidated return.

     The evidence is substantial that Georgiou, Pryor, and

Bernard then attempted to "show" beneficial ownership by

fabricating and altering documents.   The same strategy was used
                               - 42 -

to substantiate that the advances to Georgiou were loans.     The

Holding Agreement, Supply Agreement, promissory notes,

adjustments to books and records, and minutes were either created

or altered, and backdated, in an attempt to deceive the IRS

agent.   (At the conclusion of trial, respondent moved to amend

the answer to allege fraud.    The motion was denied as untimely.)

     Georgiou testified that he did not read many of the

documents he signed in either his individual capacity or as

president of Kolonaki.    Even if he did not read them, we

attribute knowledge of the documents to him.     See Bollaci v.

Commissioner, T.C. Memo. 1991-108.      The voluntary failure to read

a return and blind reliance on another for the accuracy of a

return are not sufficient bases to avoid liability for negligence

additions to tax.   Id.   See, e.g., Bagur v. Commissioner, 66 T.C.

817, 823-824 (1976), remanded on other grounds 603 F.2d 491 (5th

Cir. 1979); Bailey v. Commissioner, 21 T.C. 678 (1954).

     Petitioners' assertion that they relied on their

professional advisers is unpersuasive and incredible.

Accordingly, we sustain respondent's determination that

petitioner Georgiou is liable for the section 6662(a) accuracy-

related penalties for 1989 and 1990 and that petitioner Kolonaki

is liable for the section 6662(a) accuracy-related penalty for

1990.
                              - 43 -

B.   Sections 6653(a) and 6661 Additions to Tax

      Respondent determined an addition to tax for Kolonaki in

1989, under sections 6653(a)(1) and 6661.   Kolonaki did not

present any evidence on the negligence and substantial

understatement determinations for the 1989 tax year.    Because

Kolonaki did not meet its burden of proof, we sustain

respondent's determination that Kolonaki is liable for the

additions to tax under sections 6653(a)(1) and 6661 for 1989.

      Respondent has conceded the additions to tax under sections

6653(a) and 6661 with respect to GRS.

      To reflect the foregoing and concessions of the parties,

                                         Decisions will be entered

                                    under Rule 155.
