                       T.C. Memo. 1998-200



                     UNITED STATES TAX COURT



      JRJ EXPRESS INCORPORATED, A CALIFORNIA CORPORATION,
         d.b.a. KING EXPRESS INTERNATIONAL, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket No. 21439-96.                       Filed June 2, 1998.



    William E. Crockett, for petitioner.

    Marilyn Devin, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


    JACOBS, Judge:   Respondent determined a $1,008,874 deficiency

in petitioner's Federal income tax for tax year ended April 30,

1993, and a $201,775 section 6662(a) accuracy-related penalty.

    All section references are to the Internal Revenue Code in

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
                                       - 2 -


      Following a concession by respondent, we must decide: (1)

Whether petitioner          is   entitled   to   deduct    all   of    its    claimed

expenses; and if not, (2) whether petitioner is liable for the

section 6662(a) accuracy-related penalty.

                                 FINDINGS OF FACT

      Some of the facts have been stipulated and are so found.                    The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

      The record before us is incomplete; nonetheless, we have

attempted, as best we can, to ascertain the facts necessary to

resolve the issues before us.

Background

      Petitioner (or JRJ), a California corporation, was formed in

1988 by Jose F. Leon (J.F. Leon), its sole shareholder.                  J.F. Leon

was born in Guatemala in 1948, the third oldest brother in a family

of   12.   He   came   to    the   United   States    in    1968      after   family

infighting, and subsequently became a U.S. citizen.                    One of J.F.

Leon's brothers, Jose E. Leon, is an officer of JRJ.

      At all relevant times petitioner maintained its principal

place of business in Los Angeles, California. JRJ timely filed its

Federal income tax return for tax year ended April 30, 1993 (the

year in issue).

Petitioner's Business--"Outbound Deliveries"

      Petitioner is in the courier business, delivering letters and

small packages from the United States to Guatemala.                     During the
                                  - 3 -


year in issue, petitioner conducted business under the names "King

Express" and "JRJ Express, Inc."          JRJ operated out of 13 U.S.

offices and had some 100 employees. Approximately 78 percent of the

items petitioner delivered to Guatemala contained money orders or

checks from Guatemalans residing in the United States to their

family members back home.

     Customers who wished to use petitioner's services could: (1)

Personally   visit   one   of   petitioner's    offices,   fill   out   the

necessary form, and pay a fee; or (2) put the item, payment, and

accompanying paperwork inside an envelope that was preprinted with

petitioner's post office box address.          During the year in issue,

petitioner charged a $12 fee for: (1) Transporting the sender's

envelope from any U.S. location to petitioner's Los Angeles office;

(2) delivering the item to the addressee in Guatemala; and (3)

sending a delivery receipt to the sender.

The Guatemalan Companies

     Julio Roberto Fong (J.R. Fong) and Ricardo Alfonso Leon (R.A.

Leon),1 brothers of J.F. Leon living in Guatemala, owned and

controlled several Guatemalan companies (the Guatemalan companies)

that made deliveries of letters, packages, and other items from

Guatemala to the United States. These companies conducted business




     1
          At the time of trial, J.R. Fong was deceased; R.A. Leon
continued running the Guatemalan businesses.
                                    - 4 -


under the names "Insenasa", "King", and "King Express",2 and used

the identical company logo as petitioner.               However, neither the

Guatemalan companies nor their controlling owners had financial

interests    in    petitioner.   The    reverse   was   also   true;   neither

petitioner nor its sole shareholder had financial interests in the

Guatemalan companies.

Distribution Agreement

     In   May     1989,   petitioner,   J.R.   Fong,    R.A.   Leon,   and   the

Guatemalan companies entered into a Distribution Agreement (the

agreement) which outlined procedures for delivering petitioner's

shipments from the United States to Guatemala.             Items originating

with petitioner in the United States were shipped to Guatemala City

by air.     They were picked up at the airport by employees of the

Guatemalan companies and delivered to the recipient's Guatemalan

address by the distribution network of J.R. Fong and R.A. Leon.3

The couriers customarily secured a receipt signed by the Guatemalan

addressee, which was forwarded to petitioner's headquarters in the

United States and then mailed through the U.S. Postal Service to

the addressor as proof of delivery, together with promotional

materials advertising petitioner's services (discussed infra).




     2
          J.F. Leon, on petitioner's behalf, gave J.R. Fong and
R.A. Leon oral permission to use the name "King Express".
     3
          Items arriving in Guatemala were tracked to their
destination through a computer software program designed by J.F.
Leon.
                                   - 5 -


     Pursuant to the agreement, petitioner paid J.R. Fong and R.A.

Leon a fee (calculated as a percentage of petitioner's gross mail

courier    revenues)   for   services   provided    with    respect   to   the

Guatemalan leg of the shipment. The fee was renegotiated annually.

For the period May 1, 1992, to April 30, 1993, the fiscal year in

issue, the fee was 45 percent of petitioner's gross mail courier

revenues.

The Guatemalan Companies' Business--"Inbound Deliveries"

     The    Guatemalan    companies     offered   courier     services     from

Guatemala to the United States: items originating in Guatemala were

shipped by air to Los Angeles International Airport (by either

United or Taca International Airlines).           The shipments typically

consisted of two boxes, each weighing up to 70 pounds.            Petitioner

picked up the items five or six times a week and processed them for

delivery.    Petitioner      subcontracted   with    United    Presort      (an

unrelated company in the business of bundling bulk mail into zip

codes in order to qualify for reduced postal rates) to pick up the

items at petitioner's Los Angeles office. United Presort processed

the items and used the U.S. Postal Service to deliver the items to

their ultimate U.S. destinations.         Petitioner paid United Presort

for its service and did not seek reimbursement from the Guatemalan

companies.

     Each piece of Guatemalan inbound mail came in an envelope with

petitioner's insignia. Inside each such envelope was a smaller

envelope containing a letter or other documents originating in
                                      - 6 -


Guatemala. Additionally, inside the envelope with petitioner's

insignia    were      return      envelopes     and    promotional    brochures

advertising petitioner's business.

Oral Agreement

     J.F. Leon, on behalf of petitioner, entered into an oral

agreement with J.R. Fong and R.A. Leon, on behalf of the Guatemalan

companies, whereby in exchange for petitioner's paying various

inbound    expenses    of   the    Guatemalan    companies,   the    Guatemalan

companies   would     "stuff"     promotional    and   advertising    materials

(which included a return postage-paid envelope with petitioner's

post office box address in blue ink, instructions on how to send

money orders and packages to persons in Guatemala, and a list of

petitioner's locations in the United States) in all Guatemalan mail

bound for U.S. destinations.           The Guatemalan companies agreed to

bear the costs of printing the envelopes and advertisements. The

printing of the advertising material and "stuffing" was primarily

performed by the Guatemalan companies in Guatemala at no cost to

petitioner; a small part of the "stuffing" was performed in the

United States by petitioner's U.S. employees.

     A substantial portion of petitioner's business revenues for

tax year ended April 30, 1993, resulted from the flow of envelopes

stuffed in the Guatemalan mail bound for U.S. destinations.

Petitioner's Federal Income Tax Return

     On its Federal income tax return for tax year ended April 30,

1993, petitioner deducted the amount it paid to the Guatemalan
                                      - 7 -


companies pursuant to the Distribution Agreement. This amount

totaled 45 percent of petitioner's gross mail courier revenues for

the year or $5,163,888.          In addition, petitioner deducted other

expenses totaling in excess of $6 million and compensation to

officers in the amount of $1.87 million.

Notice of Deficiency

     In the notice of deficiency, of the total deductions claimed

on petitioner's 1993 fiscal year income tax return (apparently

including the amount paid pursuant to the Distribution Agreement),

respondent disallowed $2,952,091 on the basis that the disallowed

deductions were not for petitioner's "own ordinary and necessary

business expenses" but rather were for expenses of the Guatemalan

companies controlled by petitioner's sole shareholder's brothers.

Respondent calculated this $2,952,091 using an indirect method

beginning   with    the   cost   of   postage   on   items   mailed   to   U.S.

destinations.      Respondent then allocated a portion of petitioner's

indirect expenses to what respondent characterizes as the cost of

processing and delivering mail from Guatemala to the United States.

Due to a mathematical adjustment, respondent subsequently reduced

the disallowed amount to $2,274,751 and made a corresponding

reduction in the proposed penalty.
                                      - 8 -


                                     OPINION

Issue 1.     Section 162(a) Expenses

       The primary issue for decision is whether petitioner is

entitled to deduct expenses which respondent characterizes as the

costs of processing and delivering mail from Guatemala to the

United States.       Petitioner contends that these so-called inbound

delivery expenses were incurred for valid business reasons: (1) The

inbound mailings included petitioner's promotional materials which

generated substantial business to petitioner during the year in

issue, and (2) the inbound mailings were used to provide petitioner

with a continuously updated mailing list. Thus, petitioner asserts

that the "inbound delivery expenses" were tied directly to its

outbound courier business inasmuch as they were incurred both to

develop new business and maintain (or protect) its ability to

contact current or previous          customers.    Respondent, on the other

hand, argues that petitioner was not in the business of delivering

items from Guatemala to the United States, and thus the expenses

are nondeductible. Respondent further contends that petitioner's

business     was   not   conducted   at   arm's    length   but   rather     as   a

"cooperative       Guatemala-U.S.    venture"     between   family   members.

       Section 162(a) provides that "There shall be allowed as a

deduction all the ordinary and necessary expenses paid or incurred

during the taxable year in carrying on any trade or business".                The

test    is   whether     a   "hardheaded"       businessperson,      under    the

circumstances, would have incurred the expense. See, e.g., Cole v.
                                        - 9 -


Commissioner, 481 F.2d 872, 876 (2d Cir. 1973), affg. T.C. Memo.

1972-177.

       It is axiomatic that to be deductible under section 162, the

business expense must be incurred in the taxpayer's own trade or

business     and   not   the    trade      or   business   of   another.     E.g.,

Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943);

Deputy v. duPont, 308 U.S. 488 (1940); American Lithofold Corp. v.

Commissioner, 55 T.C. 904, 921-922 (1971); Lohrke v. Commissioner,

48 T.C. 679, 684 (1967).         A narrow exception to this rule has been

carved out for situations in which the taxpayer's payment of the

business expenses of another serves to "protect or promote" the

taxpayer's own business. See Lohrke v. Commissioner, supra at 684-

685.

       A   two-prong     test   was   enunciated      in   Lohrke   in   order    to

determine whether a taxpayer falls within the narrow "protect or

promote" exception to the general rule against a taxpayer deducting

expenses incurred on behalf of the business of another.                  First, we

must "ascertain the purpose or motive which cause the taxpayer to

pay the obligations of the other person".                  Id. at 688; see also

Snow v. Commissioner, 31 T.C. 585, 591 (1958).                       Second, the

taxpayer must show that the expense is an ordinary and necessary

expenditure    in   furtherance       of    its   trade    or   business,   not   in

furtherance of the trade or business of the other taxpayer.                 Lohrke

v. Commissioner, supra at 688.           The question must be asked: Was the
                                - 10 -


expenditure an appropriate expense to further or promote the

taxpayer's trade or business?    Id.

     In applying the first prong of the Lohrke test, we take into

account whether there is "a clear proximate danger to the taxpayer

and * * * a payment made to protect an existing business from

harm."   Young & Rubicam, Inc. v. United States, 187 Ct. Cl. 635,

410 F.2d 1233, 1243 (1969).     The deduction is not allowed if the

taxpayer fails to demonstrate "a direct nexus between the purpose

of the payment and the taxpayer's business or income producing

activities".    Lettie Pate Whitehead Found., Inc. v. United States,

606 F.2d 534, 538 (5th Cir. 1979).

     Here, the record reflects that the expenses attributable to

the incoming packages and envelopes from Guatemala had a definite

purpose related to petitioner's outbound U.S.-Guatemala courier

business.    Approximately 78 percent of items petitioner delivered

to Guatemala contained money orders or checks from Guatemalans

living in the United States to their family members back home. For

the most part, these individuals had temporary jobs and were highly

transient.     There was uncontroverted testimony that most of the

inbound mail contained requests for money.      In order to promote

petitioner's business, petitioner had to possess the means to

communicate with these transient workers. Petitioner accomplished

this by creating a "fluid mailing list" of Guatemalans living in

the United States for purposes of targeting customers.       We are
                                       - 11 -


satisfied that the lack of current customer addresses would have

represented a "clear proximate danger" to petitioner's business.

       Petitioner has also satisfied us that its "ultimate purpose"

in paying the expenses in question was to "protect or promote" its

delivery service from the United States to Guatemala, rather than

to    benefit    the   Guatemalan     companies.           Although    the   disputed

expenses related to the deliveries of packages from Guatemala to

the    United    States      which   was   the    business      of   the   Guatemalan

companies, petitioner derived a substantial benefit not otherwise

available       through   the    insertion       of   advertisements       and   other

materials of its business into the envelopes originating from

Guatemala.       The "stuffing" of these materials had a direct nexus

with petitioner's U.S.-Guatemala delivery business--the materials

provided targeted potential customers with instructions on sending

envelopes and small packages from the United States to Guatemala.

A large percentage of petitioner's revenues for the year in issue

came as a result of the flow of envelopes originating in Guatemala.

It cannot be overemphasized that the promotional and marketing

process was the centerpiece of petitioner's business.                        Thus, we

conclude that there was a direct nexus between the payment of the

expenses in dispute and petitioner's outbound delivery business.

       In applying the second prong of the Lohrke test, we are

satisfied       that   the    expenses     in    dispute    were     appropriate   in

promoting petitioner's business.                Petitioner did not specifically

deduct   "inbound      expenses"--the       expenses       in   dispute.      Rather,
                                     - 12 -


petitioner     deducted   the    amount     paid   under      the   Distribution

Agreement and all other expenses associated with the operation of

the courier business. We believe payment of the "inbound expenses"

by petitioner constituted a quid pro quo for information and

promotional    benefits   petitioner        obtained    from    the   Guatemalan

companies.       Hence,   they       were   incurred     in    furtherance    of

petitioner's     business.      As   stated    previously,      a     substantial

percentage of petitioner's business revenues for the year in issue

came as a result of the flow of envelopes originating in Guatemala

to recipients in the United States.

     The record herein reflects that J.F. Leon left Guatemala in

1968 because of a feud with his brothers.              We do not believe that

he or his brothers would have performed services for one another

gratuitously. Rather, we believe that the relationship between J.F.

Leon, on the one hand, and J.R. Fong and R.A. Leon, on the other

hand, was such that they were "`more independent in action than

strangers in blood'".     Levenson & Klein, Inc. v. Commissioner, 67

T.C. 694, 718 (1977) (quoting Jos. N. Neel Co. v. Commissioner, 22

T.C. 1083, 1090 (1954)). Accordingly, we conclude the relationship

between petitioner and the Guatemalan companies was at arm's

length.

     Because we found the relationship between petitioner and the

Guatemalan companies was at arm's length, we do not believe it

appropriate to substitute our judgment for that of J.F. Leon in

determining how much should be paid to the Guatemalan companies.
                                      - 13 -


See, e.g., John P. Scripps Newspapers v. Commissioner, 44 T.C. 453

(1965); W.L. Mead, Inc. v. Commissioner, T.C. Memo. 1975-215, affd.

551 F.2d 121 (6th Cir. 1977).           We are satisfied that the amount

petitioner paid to the Guatemalan companies was a proper business

expense and not as part of a "cooperative-Guatemalan-U.S. venture"

between family members as respondent asserts.

        To summarize, we do not sustain respondent's disallowance of

$2,952,091 from the total deductions claimed on petitioner's 1993

fiscal year income tax return.

Issue 2.         Section 6662(a) Accuracy-Related Penalty

        The next issue is whether petitioner is liable for the section

6662(a)      accuracy-related    penalty.       Section     6662(a)    imposes    a

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

underpayment of tax attributable to one or more of the items set

forth       in   section   6662(b).   Based    upon   our    holding    that     no

understatement exists, we need not address this issue.4

     To reflect the foregoing,



                                                  Decision will be entered

                                              for petitioner.




        4
          Petitioner requested that it be awarded attorney fees
in its petition and briefs. For us to now consider such an
award, petitioner must comply with the requirements of Rule 231.
