                               T.C. Memo. 2016-139



                         UNITED STATES TAX COURT



AMERICAN METALLURGICAL COAL CO. AND SUBSIDIARIES, Petitioner
      v. COMMISSIONER OF INTERNAL REVENUE, Respondent

             HEIMDAL INVESTMENT COMPANY, INC., Petitioner
          v. COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 21198-12, 25543-13.                Filed July 25, 2016.



      Derek B. Matta, for petitioners.

      Nina E. Chowdhry, Carol Bingham McClure, and Russell Scott Shieldes,

for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      COHEN, Judge: In these consolidated cases, respondent determined

deficiencies, penalties, and additions to tax as follows:
                                     -2-

[*2] American Metallurgical Coal Co. and Subsidiaries, Docket No. 21198-12

                                                Penalty
                    Year       Deficiency     sec. 6662(a)
                    2007       $3,761,314       $752,263

Heimdal Investment Company, Inc., Docket No. 25543-13

                                            Additions to tax
                                  Sec.           Sec.             Sec.
       Year     Deficiency     6651(a)(1)     6651(a)(2)          6656

       1995      $275,193     $61,918.43      $68,798.25       $27,519.30
       1996       344,006      77,401.35       86,001.50        34,400.60
       1997       415,361      93,456.23      103,840.25        41,536.10
       1998       306,664      68,999.40       76,666.00        30,666.40
       1999       666,721     150,012.23      166,680.25        66,672.10
       2000       180,000      40,500.00       45,000.00        18,000.00
       2001       180,000      40,500.00       45,000.00        18,000.00
       2002       340,342      76,576.95       85,085.50        34,034.20
       2003       180,000      40,500.00       45,000.00        18,000.00
       2004       180,000      40,500.00       45,000.00        18,000.00
       2005       478,908     119,727.00      119,727.00        47,890.80
       2006       180,000      45,000.00       45,000.00        18,000.00
       2007     2,168,979     488,020.28      542,244.75       216,897.90
       2008        50,515      11,365.88       12,628.75         5,051.50
                                        -3-

[*3] Unless otherwise indicated, all section references are to the Internal

Revenue Code (Code) in effect for the years in issue, and all Rule references are to

the Tax Court Rules of Practice and Procedure.

      The remaining five issues for decision are:

Docket No. 21198-12

      (1) whether American Metallurgical Coal Co. and Subsidiaries (Norse

Group) is entitled to deduct a purported interest expense of $7,229,930 for the

2007 tax year and if so, whether it is entitled to a net operating loss (NOL)

deduction for that year; and (2) whether the Norse Group is liable for an accuracy-

related penalty under section 6662(a) for the 2007 tax year;

Docket No. 25543-13

      (3) whether Heimdal Investment Company, Inc. (Heimdal), is liable for 30%

withholding tax on the gross amounts of distributions it made to a foreign entity

from 1995 through 2008; (4) whether Heimdal is liable for the failure to file

addition to tax under section 6651(a)(1) for tax years 1995-2008; and (5) whether

Heimdal is liable for the failure to deposit addition to tax under section 6656 for

tax years 1995-2008.
                                        -4-

[*4]                          FINDINGS OF FACT

       The stipulation of facts and the accompanying exhibits are incorporated

herein by this reference. At the time their petitions were filed, the Norse Group’s

and Heimdal’s principal places of business were in Texas. Although the Norse

Group formally began filing returns on a consolidated basis in 1995, we use the

term “the Norse Group” to mean AMC and its subsidiaries, past and present.

       The Norse Group comprises the American Metallurgical Coal Co. (AMC)

and its subsidiaries, which include Heimdal. AMC is a domestic corporation that

is indirectly wholly owned by Jan Petter Roed, a Norwegian shipowner who has a

background in shipping and ore transportation. The focal point of these cases is a

transaction between Heimdal and Lausanne Energy, Inc. (Lausanne), a Liberian

corporation, that took place over the course of tax years 1995 through 2008, the

years in issue.

Brief History of Lausanne and the Norse Group’s Business Relationship

       Lausanne and the Norse Group have a business relationship that dates back

to 1984. Since 1984, a current Norse Group subsidiary, Norse Services, has

provided management services to Lausanne and acted as Lausanne’s agent in the

United States. In 1984, Lausanne purchased a company, Heimdal Investment Co.

N.V. (Heimdal NV), that was formerly a member of the Norse Group. At that time
                                         -5-

[*5] Heimdal NV was an original investor in Caithness Geothermal 1980, LTD

(CG), a domestic privately held partnership and independent power producer

based in southern California. CG developed, owned, managed, and operated

geothermal projects in that region under power purchase agreements with

Southern California Edison Co. In 1986, Lausanne made a direct investment in

CG by contributing $1,080,000 to the partnership in exchange for three limited

partnership units.

      In 1986, AMC was a general partner in a domestic partnership called Allied

Minerals. That year, it granted two banks a security interest in the distributions it

received from Allied Minerals. In 1987, AMC’s parent company underwent a

reorganization in response to the termination of the United States-Netherlands

Antilles tax treaty. At the time AMC’s president, Torgeir Mantor, consulted with

Robert Pfaff, a partner at KPMG, about the tax aspects of the reorganization. The

purpose of the reorganization was to “ensure the preservation of net operating loss

(NOLs) carry forwards for possible future use.” As a result of the reorganization,

AMC lowered its tax burden and generated substantial NOLs, but it was still

subject to the security interests held by the banks, in particular Den norske Bank

(DnB).
                                        -6-

[*6] AMC incorporated Heimdal in 1987 as a domestic holding company of

Lausanne’s interests. Heimdal’s first director was Hans Rinderknecht

(H. Rinderknecht), a Swiss lawyer who had previously represented Lausanne in

negotiations concerning its 1984 services agreement with Norse Services. In

1987, H. Rinderknecht was also the director of Lausanne. His son, Dr. Thomas

Rinderknecht (T. Rinderknecht), was Lausanne’s managing director for the years

in issue.

Leading Up to the Transaction Between Heimdal and Lausanne

      In 1991, distributions from CG caused Lausanne to turn a profit, and it

became liable for U.S. income tax, specifically the branch profits tax, which it paid

via withholding in that year. Later that year T. Rinderknecht initiated discussions

with Mantor over how to make changes to Lausanne’s investment in CG because

income from the CG partnership had “grown to be substantial” and Lausanne

might face “branch profits taxation problems.” T. Rinderknecht asked Mantor to

reach out to tax experts about restructuring Lausanne’s investments to reduce the

potential tax exposure. Mantor contacted Pfaff and apprised him of Lausanne’s

situation. He also told Pfaff that the Norse Group had an interest in participating

in some way.
                                        -7-

[*7] On November 21, 1991, Pfaff mailed a preliminary letter to Mantor

proposing that Lausanne contribute its CG partnership interest to the Norse Group

in exchange for shares and possibly debentures. Pfaff believed the proposal would

appeal to Lausanne because the Norse Group’s NOLs “would shelter the income in

all likelihood” but expressed concern that “the security agreement with the bank”

would make his proposal unlikely to be implemented.

      In the fall of 1992, the parties further discussed restructuring Lausanne’s

investment in CG for tax purposes. On December 10, 1992, Mantor faxed a

proposed diagram of the Norse Group to T. Rinderknecht. The fax cover sheet

advised T. Rinderknecht that DnB was a creditor of the Norse Group and had

agreed only to hold a security interest in a newly formed subsidiary company,

“Newco”, which would hold AMC’s coal properties. Therefore, Mantor believed

that DnB would “not be in a position to attack any assets other than what is held in

this company.” Mantor’s diagram identified that AMC would be the parent

company of Heimdal, Newco, and AMC’s other subsidiaries. The diagram also

identified Lausanne, as the holder of a security interest with respect to Heimdal,

and Newco, as the Norse Group subsidiary that “[o]wns coal properties and has

bank debt”.
                                         -8-

[*8] On December 11, 1992, Pfaff mailed a letter to Mantor and T. Rinderknecht

outlining the tax impacts of a proposed sale of Lausanne’s CG partnership units to

Norse Services. In the letter Pfaff indicated that Lausanne would transfer its CG

partnership interest in exchange for a note with principal due upon maturity. He

suggested that the terms of the note call for the payment of fixed interest at an

assumed rate of 12% over a term (not to exceed seven years) and additional

interest whereby Lausanne would share in excess “cash flow”. He assumed a

maximum purchase price of $5 million for the CG partnership interest and

suggested that Lausanne perfect a security interest in the CG partnership units

such that in the event of a default by the Norse Group subsidiary, Lausanne would

have first deed on the partnership interest. Pfaff determined that the transaction

would be characterized as an installment sale for tax purposes and that Lausanne

would defer recognition of gain on the sale of its CG partnership interest until

Lausanne recovered the note’s principal. He stated that this was the case

regardless of the fact that section 897 would classify the CG partnership interest as

a U.S. real property interest and possibly subject Lausanne to withholding tax

under the Foreign Investment in Real Property Tax Act (FIRPTA). Pfaff also

concluded that the interest paid to Lausanne would be considered “portfolio

interest”, free from withholding taxes under section 871(h). He concluded his
                                         -9-

[*9] letter by stating that in order for the sale to proceed, several tasks would have

to be completed, including applying for an exemption so that the FIRPTA

withholding tax rules would not apply, and that the parties should “evaluate very

carefully the economic value of the partnership interest to negotiate an arm’s

length sales price.”

      On December 17, 1992, Mantor sent Roed a cashflow analysis which he

believed showed “the tax benefits” of the transaction. Mantor stated that the

analysis was a “quick draft” that was “based on some information which needs to

be discussed with Lausanne.” In the analysis he compared the after-tax profit to

the Norse Group “with reorganization” and the after-tax profit to Lausanne

“without reorganization” for the period 1992-2000. The analysis assumed that

total distributions from CG would be $8,514,819 from 1992-2000 for both

scenarios. He believed that he had a pretty good idea of what the cashflow and

income would be from CG because he had access to all of CG’s documentation

pursuant to the services agreement between Lausanne and Norse Services.

      The analysis assumed that the Norse Group would give a note payable to

Lausanne worth $5 million “@ 12% interest only for seven years” and an “[e]quity

kicker of 45-50% of [the] remaining cash flow.” The analysis projected how the

Norse Group’s NOLs and expected interest expenses to Lausanne would offset
                                         - 10 -

[*10] anticipated distributions from CG. In the end the analysis projected a total

after-tax profit for the Norse Group of $1,573,813 “with reorganization” and a

total after-tax profit for Lausanne of $3,337,809 “without reorganization”. In

projecting the after-tax profit to the Norse Group “with reorganization”, the

analysis assumed that the Norse Group would pay to Lausanne 79% of the total

distributions from CG. The analysis did not provide for the Norse Group’s

repayment of the principal of the note to Lausanne.

      At some point during this time, Lausanne and the Norse Group agreed that

the transaction regarding the CG partnership units would be between Lausanne

and Heimdal. On December 21, 1992, T. Rinderknecht faxed a letter to Mantor

and Pfaff regarding the sale of Lausanne’s CG partnership interest to Heimdal. In

the letter T. Rinderknecht stated that he had spoken with Jim Bishop of Caithness

Corp. (CC), the general partner of CG. Bishop was the president and CEO of CC,

and he assured T. Rinderknecht that CC would cooperate with Lausanne and the

Norse Group on the transaction. Bishop believed that in the foreseeable future the

limited partners of CG, like Lausanne, would be taxed for distributions only up to

their net capital investment and that thereafter all distributions to the partners

would be tax free. He advised T. Rinderknecht to contact CC’s tax adviser

regarding this assessment and before selling Lausanne’s partnership interest. T.
                                       - 11 -

[*11] Rinderknecht requested that Pfaff contact CC’s tax adviser to verify whether

it was true that Lausanne would not face adverse tax consequences if it retained

the CG units for a while. T. Rinderknecht also insisted that in the event Lausanne

were to sell its CG partnership units to Heimdal, Lausanne retain an option to

repurchase the units from Heimdal. T. Rinderknecht insisted on an option period

of “not less than 15 years” and that Lausanne should be able to repurchase the

units for a price “consisting of the purchase price paid by Heimdal increased by a

certain margin for Heimdal.”

      On December 22, 1992, Mantor faxed a memorandum to Roed regarding

“Norse Restructuring”. The memorandum outlined the background, structure, tax

considerations, and risk factors of two transactions. The first transaction was a

continuation of AMC’s 1987 reorganization and involved a new AMC

subsidiary’s owning of assets that had been previously owned by two AMC

affiliates. This new subsidiary would assume and be responsible for all of the

bank debt associated with the assets and would join in AMC’s consolidated return.

As a result of the restructuring, Mantor believed that AMC would be able to use a

combined NOL of approximately $20 million. The second transaction involved

Heimdal’s purchase of Lausanne’s CG partnership units. Mantor summarized the

structure of the second transaction as follows: (1) Heimdal would purchase
                                          - 12 -

[*12] Lausanne’s interest in CG for a note to be negotiated of no more than $5

million with interest only for seven years; (2) Lausanne would be given an “equity

kicker” of no more than 50% of the remaining annual distribution from CG; and

(3) Lausanne would also be given an option to purchase the interest back from

Heimdal if certain further development of the geothermal properties were to occur.

As a result of this transaction, Mantor believed that Heimdal would have high

deductible interest expenses which would partially reduce its taxable income in the

United States. He also believed that Heimdal’s remaining income would be

reduced by the use of the NOLs in AMC. Attached to Mantor’s fax was a copy of

Pfaff’s December 11, 1992, letter.

The Letter Agreement and the Promissory Note

      On December 31, 1992, the parties signed a written letter agreement

whereby Heimdal agreed to purchase Lausanne’s three partnership units (referred

to as “Units” in the agreement) in CG (referred to as “Partnership”) for a purchase

price of $5 million, payable with a promissory note (referred to as “Note”).

      The letter agreement included the following relevant terms:

      (4)(f) without * * * [Lausanne’s] prior written consent, (which * * *
      [Lausanne] may withhold in * * * [its] sole and absolute discretion)
      * * * [Heimdal] will not (i) liquidate, (ii) merge or consolidate with
      any other entity, (iii) sell all or substantially all of its assets, (iv) enter
      into or engage in any business other than ownership of the Units, (v)
                                        - 13 -

      [*13] enter into any guarantees or pledge any of * * * [its] assets
      other than liabilities in the ordinary course of business not exceeding
      an aggregate of $100,000 in any year and liabilities in * * *
      [Lausanne’s] favor. * * *

      (7) * * * [Heimdal] undertake[s] to cause the Partnership to deliver to
      * * * [Lausanne] copies (for so long as the Note remains outstanding)
      of all notices and correspondence which are sent to * * * [Heimdal]
      are generally distributed by the Partnership to its limited partners at
      the same time such materials are sent or distributed. In the event the
      Partnership fails to timely deliver such materials to * * * [Lausanne],
      * * * [Heimdal] will immediately send * * * [Lausanne] copies
      thereof. In addition, for so long as the Note remains outstanding
      * * * [Heimdal] shall provide * * * [Lausanne] with access to all
      books and records pertaining to the Units.

      (8) In the event it is proposed that the limited partners make any
      capital contribution to the Partnership in respect of their units, * * *
      [Lausanne] and * * * [Heimdal] agree to consider in good faith
      whether the Cash Flow Interest provisions of the Note should be
      modified to reflect the economic effect of such capital contribution.

      That same day, Heimdal furnished Lausanne with a $5 million promissory

note that was payable on December 31, 2002, as consideration for the transaction.

The promissory note included the following terms:

      The principal balance of this Note shall bear interest at the rate of
      twelve percent (12%) per annum (based on a 360 day year). Such
      interest shall be payable annually in arrears on December 31, of each
      year and upon the maturity of the principal hereof (upon the stated
      maturity hereof, prepayment, acceleration or otherwise); provided
      however, that upon Payor receiving any distribution from * * * the
      Partnership * * * with respect to the three (3) * * * Units * * * of
      limited partnership interest in the Partnership purchased as of the date
      hereof by Payor from Payee, Payor shall apply such distribution to
                                 - 14 -

[*14] pay (or prepay) any interest accrued (or which shall thereafter
accrue during the then current calendar year) hereunder.

In addition to the 12% interest described above, additional interest
(“Cash Flow Interest”) equal to fifty percent (50%) of the excess, if
any, of (i) distributions paid by the Partnership in any calendar year
over (ii) the sum of (A) six hundred thousand dollars ($600,000) and
(B) the reasonable costs of collection of such distributions, if any,
shall be due and payable by Payor to Payee immediately upon receipt
of any such distribution which represents, in whole or in part, any
such excess.

Any principal or interest (including Cash Flow Interest) not paid
when due hereunder shall bear at a rate of 16% per annum.

Payor shall not prepay the principal amount of this Note without the
prior written consent of Payee (which may be withheld in Payee’s
sole and absolute discretion).

This Note is entitled to the benefits of the Security Agreement of even
date herewith between Payor, as debtor, and Payee, as secured party
(the “Security Agreement”) * * *

The transfer of this Note (which as provided in the Payee’s Note may
only occur with the prior written consent of Payor) is registerable on
the note registry maintained by Payor, upon surrender of this Note for
registration of transfer at the address of Payor * * *, duly endorsed
by, or accompanied by a written instrument of transfer and duly
executed by the holder or its attorney, duly authorized in writing, and
thereupon a new note in the same principal amount will be issued by
Payor to the designated transferee.

Each of the following events shall constitute an Event of Default
hereunder:
                                   - 15 -

[*15] (a) if any portion of the principal, interest or other amounts
      payable by Payor under this Note is not paid within five (5)
      days after the same is due;

      (b) if Payor violates or does not comply with any of the
      provisions of this Note * * * [or] the Letter Agreement; * * *

      (d) if Payor shall make an assignment for the benefit of
      creditors; * * *

      (f) if the Partnership shall sell all or substantially all of its
      properties or liquidate; or

      (g) if any Event of Default (as defined in the Security
      Agreement) shall occur.

Upon the occurrence at any time of any of the foregoing Events of
Default, (i) Payee may, by written notice to the Payor, declare the
outstanding balance of the principal and interest payable hereunder to
be immediately due and payable, upon which declaration such
principal and interest shall be immediately due and payable * * *

Notwithstanding anything to the contrary contained in this Note or in
any other instruments or documents executed and delivered in
connection herewith, in no event shall the total of all charges payable
under this Note which are or could be held to be in the nature of
interest, exceed the maximum rate permitted to be charged by
applicable law of the State of New York. Should payee receive any
payment which is or would be in excess of that permitted to be
charged under any such applicable law, such payment shall have
been, and shall conclusively be deemed to have been, made in error
and shall automatically thereupon be applied to reduce the unpaid
principal amount then outstanding on this Note. This provision shall
control interpretation of any other conflicting provisions in this Note
and any other instruments or documents executed and delivered in
connection herewith or therewith with respect to the payment of
interest. * * *
                                        - 16 -

      [*16]This Note may not be waived, changed, modified, terminated or
      discharged orally, but only by agreement in writing signed by the
      holder hereof.

Pfaff’s Memorandum of Advice to T. Rinderknecht

      On February 11, 1993, Pfaff mailed a letter to T. Rinderknecht, copying

Mantor, that included a memorandum of advice concerning the tax consequences

of the transaction between Heimdal and Lausanne. The memorandum explained

that the transaction was effected as had been outlined in Pfaff’s December 11,

1992, letter, with the modification that the sale was made to Heimdal instead of

Norse Services, and that the promissory note was for a term of 10 years rather than

“no more than seven years.” Pfaff’s memorandum concluded that the transfer of

the CG units from Lausanne to Heimdal could be treated as an installment sale and

that withholding on the disposition of a U.S. real property interest would therefore

be required when Heimdal made a principal payment to Lausanne. Pfaff also

observed that the note included a provision whereby cashflow interest on the note

was limited to the maximum allowable interest under New York State law and

concluded that this provision would be sufficient to classify these payments as

interest payments rather than additional principal payments.

      The memorandum also informed T. Rinderknecht and Mantor that U.S.

interest paid by a U.S. entity to a foreign corporation is generally subject to 30%
                                       - 17 -

[*17] tax under section 881 and withholding under section 1442, but portfolio

interest is exempt from U.S. tax under section 881(c). Pfaff explained that in order

to meet the portfolio interest exception, Heimdal had to receive a Form W-8,

Certificate of Foreign Status, from Lausanne before making payment, attach the

completed Form W-8 with Form 1042-S, Foreign Person’s U.S. Source Income

Subject to Withholding, to Form 1042, Annual Withholding Tax Return for U.S.

Source Income of Foreign Persons, and file Form 1042 with the Internal Revenue

Service by March 15 following the calendar year of the payment. The

memorandum stated that Form W-8 would be valid for three years but could be

requested annually or before each payment. The memorandum concluded that the

note “appears to be registered, and will meet the portfolio interest exception of

section 881(c) if the payor receives a statement that the beneficial owner of the

obligation is not a United States person.” The memorandum was not a full tax

opinion letter subject to prior review with the KPMG Washington national office.

Modifications to the Promissory Note

      On December 31, 2002, Heimdal and Lausanne extended the term of the

note to December 31, 2005 (2002 extension). All other terms and conditions of

the note, including those with respect to fixed interest and cashflow interest, were
                                         - 18 -

[*18] incorporated in the 2002 extension and remained in full force and effect

during the term of the 2002 extension.

      On October 28, 2004, Heimdal and Lausanne amended the promissory note

agreement to state that Heimdal would accrue, rather than pay up front, the fixed

interest of $600,000 for each of 2003, 2004, 2005. The amendment occurred after

Heimdal had received distributions from CG in 2003 that were less than the

$600,000 fixed interest payment due to Lausanne for that year.

      On December 22, 2005, Heimdal and Lausanne extended the term of the

note to December 31, 2006 (2005 extension). The 2005 extension provided that

certain other terms and conditions of the note, including the fixed rate of interest

and the rate of cashflow interest, would be renegotiated in good faith but provided

that should the parties not agree on revised terms, the existing terms of the 2002

extension would remain in full force and effect.

      Finally, on December 26, 2006, Heimdal and Lausanne extended the term of

the note to December 31, 2009 (2006 extension). As part of the 2006 extension,

Heimdal and Lausanne agreed to reduce the fixed interest rate portion of the

agreement from 12% to 6% and prohibit prepayment of the principal. During the

period covered by the 2006 extension, Heimdal continued to pay fixed interest to

Lausanne at the rate of 12% rather than the reduced rate of 6%.
                                      - 19 -

[*19] On January 29, 2008, Heimdal prepaid the $5 million principal amount of

the note to Lausanne.

CG’s Investor Relations Report and Heimdal’s Profit and Loss Statements

      CG’s Investor Relations report states that from December 31, 1992, through

March 31, 2009, Heimdal received distributions of approximately $35.6 million

from CG. Heimdal reported on its profit and loss statements that it had remitted

approximately $22.7 million to Lausanne as interest payments during this period.

In 2007 alone Heimdal received distributions from CG totaling $14,170,452. For

that year Heimdal reported that it had remitted approximately $7,229,930 to

Lausanne as interest payments. Heimdal’s profit and loss statements for 1993-

2007 showed that it had received “consulting income” totaling $923,473.67 in

2004-07. Presumably, Heimdal had received the “consulting income” in violation

of the letter agreement between Heimdal and Lausanne, which prohibited Heimdal

from engaging in any business other than ownership of the CG units without

Lausanne’s prior written consent.

Tax Reporting

      For 1993-2008, Heimdal did not file Forms 1042 or Forms 1042-S. In these

same years Heimdal did not deposit or pay any withholding tax on distributions it

made to Lausanne. The record shows that Lausanne sent Heimdal one completed
                                           - 20 -

[*20] Form W-8 dated December 31, 1992, certifying that Lausanne was not a

U.S. citizen or resident.

                                     OPINION

I.    Burden of Proof

      Generally, the taxpayer has the burden of proving that the determinations in

the notice of deficiency are incorrect. Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933). We resolve these issues on the preponderance of the evidence in

the record. See Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).

II.   The Tax Implications of the Transaction Between Heimdal and Lausanne

      Section 881(a)(1) generally imposes a tax of 30% on “fixed or determinable

annual or periodical” (FDAP) income received from sources within the United

States by a foreign corporation if the income is not effectively connected with the

conduct of a United States trade or business. This tax may be reduced under a

bilateral income tax treaty between the United States and the foreign corporation’s

country of residence. See sec. 894(a)(1). Because the transaction in these cases

involves Heimdal, a domestic entity, and Lausanne, an entity incorporated in a

country that does not have a tax treaty with the United States, we look to the Code

for the rules governing the transaction.
                                        - 21 -

[*21] The Code defines FDAP income broadly and includes in it income from

interest payments. See Commissioner v. Wodehouse, 337 U.S. 369, 393-394

(1949). The U.S. payors of such income are generally required under sections

1441 and 1442 to deduct and withhold therefrom an amount equal to the tax

imposed by sections 871 and 881, and in the event that they fail to do so they are

liable for those withholding taxes under section 1461.

      In 1984, Congress repealed the 30% withholding tax imposed by sections

871 and 881 with respect to certain interest paid on portfolio debt, referred to as

“portfolio interest”. For the most part, and as relevant here, portfolio interest

refers to interest payments made to a foreign corporation (owning less than 10% of

the payor entity) pursuant to debt obligations that are either in registered form with

the appropriate certification or sold exclusively to non-U.S. persons with proper

precautions taken that such debt obligations will not be held by U.S. persons. See

secs. 881(c), 163(f)(2)(B).

      The remaining issues in these two cases turn on whether the transaction

between Heimdal and Lausanne generated bona fide portfolio interest payments

for tax purposes from the former to the latter. If the disbursements were bona fide

for tax purposes, the Norse Group would be able to deduct the payments on its

2007 consolidated tax return. As a result no penalty would be imposed on the
                                        - 22 -

[*22] Norse Group for including this large deduction on its 2007 return.

Furthermore, Heimdal would not have to withhold tax on behalf of Lausanne for

the years in issue--provided certain formalities were met--and no additions to tax

would be imposed for its failure to do so.

      Before we decide whether Heimdal’s payments to Lausanne meet the

reporting requirements for it to claim the portfolio interest exemption from

withholding, we must first decide whether Heimdal’s payments were genuine

interest payments.

      A.     Bona Fide Debt

      The question of whether Heimdal’s payments to Lausanne were bona fide

interest payments is a factual question to be decided on the basis of all of the

relevant facts and circumstances. See Haber v. Commissioner, 52 T.C. 255, 266

(1969), aff’d, 422 F.2d 198 (5th Cir. 1970); Roschuni v. Commissioner, 29 T.C.

1193, 1201-1202 (1958), aff’d, 271 F.2d 267 (5th Cir. 1959). For a promissory

note to constitute bona fide indebtedness, there must be an unconditional legally

enforceable obligation to pay the money. Horn v. Commissioner, 90 T.C. 908,

938 (1988). The “simple expedient of drawing up papers” is not controlling for

tax purposes when “the objective economic realties are to the contrary.” Frank

Lyon Co. v. United States, 435 U.S. 561, 573 (1978).
                                         - 23 -

[*23] The U.S. Court of Appeals for the Fifth Circuit has identified nonexclusive

factors to be considered in distinguishing bona fide indebtedness from an equity

investment or other return on capital. See Estate of Mixon v. United States, 464

F.2d 394, 402 (5th Cir. 1972). Some of these factors are as follows: (1) the names

given to the certificate evidencing the indebtedness; (2) the presence or absence of

a fixed maturity date; (3) the source of the funds used to pay interest and repay the

creditor; (4) the right to enforce the payment of principal and interest; (5) the

extent of a creditor’s participation in management; (6) the status of the advance in

relation to other corporate creditors; (7) the intent of the parties; (8) thinness of

capital structure in relation to the debt; (9) identity of interest between creditor and

stockholder; (10) the debtor’s ability to obtain loans from outside lending

institutions; (11) the extent to which the advance was used to acquire capital

assets; and (12) the failure of the debtor to pay on the due date or to seek a

postponement. See id.; In re Indian Lake Estates, Inc., 448 F.2d 574, 578-579 (5th

Cir. 1971); PK Ventures, Inc. v. Commissioner, T.C. Memo. 2006-36, aff’d in

part, rev’d in part on other grounds, and remanded sub nom. Rose v.

Commissioner, 311 F. App’x 196 (11th Cir. 2008).

      The identified factors are not equally significant, and no single factor is

determinative in each case or relevant in every case. See Jones v. United States,
                                        - 24 -

[*24] 659 F.2d 618, 622 (5th Cir. 1981); Calumet Indus., Inc. v. Commissioner, 95

T.C. 257, 285 (1990). The real issue for tax purposes has long been held to be the

extent to which the transaction complies with arm’s length standards and normal

business practice. Estate of Mixon, 464 F.2d at 403. The various factors are only

aids in answering the ultimate question of whether there was “a genuine intention

to create a debt, with a reasonable expectation of repayment, and did that intention

comport with the economic reality of creating a debtor-creditor relationship?’”

Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367, 377 (1973); see also Calumet

Indus., Inc. v. Commissioner, 95 T.C. at 285-286; Dixie Dairies Corp. v.

Commissioner, 74 T.C. 476, 494 (1980). The form of the transaction and the

labels the parties place on the transaction may not have as much significance when

the parties can mold the transaction at their will. Calumet Indus., Inc. v.

Commissioner, 95 T.C. at 286. The Internal Revenue Service recently released

proposed regulations in an attempt to bring clarity and consistency to the analysis

of distinguishing between indebtedness and equity investments. See Notice of

Proposed Rulemaking, 81 Fed. Reg. 20912 (Apr. 8, 2016). Because the

transaction at issue in these cases took place more than 20 years ago, we mention

these regulations for posterity’s sake only.
                                         - 25 -

[*25] Applying the above factors we find that the advance of the purchase price of

the three CG partnership units from Lausanne to Heimdal was not a bona fide loan

but an equity investment. The Norse Group and Lausanne worked together to

create a transaction that reduced their respective tax liabilities, rather than create a

strict debtor-creditor relationship, and this was their sole objective.

      The Norse Group may have established the existence of a formal debt

instrument with a fixed maturity date at the outset, but it did not establish that any

of the note’s terms were properly negotiated. The terms of the promissory note

were largely based on Pfaff’s December 11, 1992, letter, which proposed a $5

million dollar note that provided for 12% fixed interest and additional cashflow

interest. Pfaff recommended that Heimdal and Lausanne obtain a valuation of the

CG partnership units before their sale so that they could show that they were

dealing at arm’s length, but they did not obtain one. Furthermore, Pfaff stated at

trial that he did not know how the 12% fixed interest rate was devised. An asset’s

sale price may be considered to be at arm’s length where each party in the

transaction can “distinguish his economic interest from that of the other party and,

where they conflict, always choose that to his individual benefit.” See Creme

Mfg. Co. v. United States, 492 F.2d 515, 520 (5th Cir. 1974). Here, that simply

did not occur. Nothing in the record suggests that these terms were negotiated.
                                       - 26 -

[*26] Although the note had a 10-year fixed maturity date at the outset of the

transaction, that maturity had to be postponed for 7 years because Heimdal did not

have sufficient cashflow stemming from the CG distributions to repay the note on

time. The repayment of the debt was strictly contingent upon the success of the

CG partnership units to generate income, suggesting equity classification. See

Slappey Drive Indus. Park v. United States, 561 F.2d 572, 582-583 (5th Cir.

1977).

      As a condition to the transfer of the three CG partnership units to Heimdal,

Lausanne obtained the right to approve of Heimdal’s business activities and debts

and precluded Heimdal from engaging in any other business activities and

incurring any other debt. When an entity advances funds for the right to

participate in the management of the debtor’s business, the advance may not be

intended as bona fide debt and instead may be intended as an equity investment.

See Am. Offshore, Inc. v. Commissioner, 97 T.C. 579, 603 (1991). Under the

restrictive terms of the letter agreement, Lausanne effectively managed Heimdal.

      The Norse Group places great weight on its professed intent to enter into a

debtor-creditor relationship with Lausanne and its reflection of the debt as such in

its and Lausanne’s books, records, and tax returns. The intent of the parties

weighs heavily in determining the debt versus equity question, but subjective
                                        - 27 -

[*27] intent does not suffice to alter the relationship or duties created by an

otherwise objectively indicated intent. In re Lane, 742 F.2d 1311, 1316 (11th Cir.

1984). Conclusory and self-serving statements by taxpayers that they intended to

create debts have been accorded little weight by the courts. The Court of Appeals

for the Fifth Circuit has stated: “Primary reliance upon subjective indications of

intent is simply not an effective way of resolving * * * [the debt versus equity]

problem. In a land of hard economic facts, we cannot root important decisions in

parties’ pious declarations of intent.” Tex. Farm Bureau v. United States, 725

F.2d 307, 314 (5th Cir. 1984).

      Thus, we must look not simply at the pronouncements of the parties but also

at the circumstances surrounding the transaction to reveal their intent. Tyler v.

Tomlinson, 414 F.2d 844, 850 (5th Cir. 1969). The circumstances surrounding

Lausanne’s transfer of its three CG partnership units to Heimdal reveal that they

did not intend to enter into a debtor-creditor relationship.

      In late 1991, it became apparent that Lausanne might be liable for the

branch profits tax as its ownership of the CG units was becoming profitable

around that time. Rather than try to address this issue using its own business

exigencies, it worked in conjunction with the Norse Group to find a mutually

compatible way to lower both companies’ tax burdens. In late 1991 and
                                         - 28 -

[*28] throughout 1992, Mantor and T. Rinderknecht regularly corresponded with

one another regarding the transaction.

      Meanwhile, the Norse Group reached out to its own tax adviser, Pfaff,

regarding the transaction. Mantor would ask for Pfaff’s advice regarding certain

aspects of the deal, and he would pass along Pfaff’s advice to T. Rinderknecht.

Mantor’s correspondence with Pfaff was not necessarily as concerned with the

Norse Group’s sole business or tax consequences regarding the deal as it was with

the Norse Group’s and Lausanne’s tax consequences together. At some point

Pfaff started to communicate directly with T. Rinderknecht regarding the salient

terms of the deal. These discussions suggest that the Norse Group’s and

Lausanne’s dealings were not at arm’s length. See Creme Mfg. Co., 492 F.2d at

520 (noting that a transaction is not at arm’s length if each party is not in a

position to distinguish its own economic interests from the other’s).

      The parties continued to act in concert with one another to devise a seller-

financed purchase of the CG partnership units that was mutually beneficial to the

Norse Group and Lausanne. In the months leading up to the transaction, Mantor

created a cashflow analysis for the Norse Group that analyzed the contemplated

transaction. In this analysis Mantor considered the tax ramifications to both the

Norse Group and Lausanne. He was able to consider Lausanne’s tax implications
                                        - 29 -

[*29] because he had its financial data from a previous agreement. His concern

over the tax aspects for Lausanne implies that the Norse Group was not primarily

concerned with its own business interests but, instead, with creating a mutually

beneficial arrangement with Lausanne. Thus, the Norse Group and Lausanne’s

ability to mold the transaction to their collective will diminishes any significance

that the transaction’s form and labels may have held as determinants of bona fide

debt. See Calumet Indus., Inc. v. Commissioner, 95 T.C. at 286.

      The Norse Group admits that the source of the repayment of its debt to

Lausanne was the CG partnership distributions it purchased from Lausanne.

Heimdal had no assets at the time it entered into the transaction to purchase the

CG partnership units, and it required an advance of the entire purchase price from

Lausanne. This fact strongly suggests that Lausanne’s advance to Heimdal was

equity rather than debt. See United States v. Henderson, 375 F.2d 36, 40 (5th Cir.

1967).

      Moreover, Heimdal’s and Lausanne’s conduct while the note was

enforceable indicates that they did not consider the note to be genuine

indebtedness. Heimdal violated the terms of the letter agreement by failing to pay

interest timely in 2003 and 2004. Rather than treat the note as defaulted on,

however, Lausanne allowed Heimdal to accrue interest and continue holding the
                                         - 30 -

[*30] CG units for several years after the original maturity date. Furthermore, the

2006 extension reduced the fixed interest rate from 12% to 6%, yet in 2007,

Heimdal paid Lausanne fixed interest at the higher 12% rate. Where a debtor does

not make required payments or a creditor does not enforce its right to receive

payments, an advance appears more like equity than debt. Ambassador

Apartments, Inc. v. Commissioner, 50 T.C. 236, 246 (1968), aff’d, 406 F.2d 288

(2d Cir. 1969).

      In the end the Norse Group and Lausanne devised a transaction whereby

Lausanne would sell the CG partnership units in exchange for a promissory note

from Heimdal that generated interest payments to Lausanne. The terms of the

agreement prevented Heimdal from engaging in any business other than holding

the CG units and provided Lausanne with access to Heimdal’s books and records

pertaining to the CG units. Because some portion of the interest payments was

contingent on the performance of CG, Lausanne would still generate income from

CG without having to pay the branch profits tax. They anticipated that a portion

of the interest could be classified as portfolio interest (provided the legal

formalities were met). Therefore, Heimdal could claim interest deductions on the

interest payments and offset the income generated by its new ownership of the CG

units with the NOLs of the Norse Group. In substance the economics of the
                                        - 31 -

[*31] transaction remained the same--Lausanne generated income from the CG

units and had substantial control over the units themselves. The expected extra

benefit was that both Lausanne and the Norse Group received large tax advantages

for having the transaction structured in this way.

      In Frank Lyon Co., 435 U.S. at 583-584, 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. Many cases demonstrate the difference between

arranging a contemplated business transaction in a tax-advantaged manner, which

is legitimate, and entering into a prearranged transaction designed solely to use

preserved NOLs and create a tax benefit, which is not. See, e.g., Stobie Creek

Invs., LLC v. United States, 608 F.3d 1366, 1375 (Fed. Cir. 2010); Coltec Indus.,

Inc. v. United States, 454 F.3d 1340, 1357 (Fed. Cir. 2006); Vulcan Materials Co.

v. United States, 446 F.2d 690, 699-700 (5th Cir. 1971). We believe Mantor and

T. Rinderknecht, with the approval of Roed, created this transaction solely to

generate a tax benefit. The Norse Group and Lausanne designed and implemented

this elaborate system to create the appearance that Heimdal was paying interest,

while in substance it was not. Therefore, the payments were not deductible by the
                                       - 32 -

[*32] Norse Group, and they were FDAP income, which required Heimdal to

withhold income tax.

      B.     Reporting Requirements To Meet the Portfolio Interest Exemption

      Although we find that the Norse Group did not really pay interest to

Lausanne for purposes of section 881(c), an alternative ground for decision is that

Heimdal did not meet the reporting requirements to satisfy the portfolio interest

exemption.

      In order for a debtor paying interest on registered debt to a foreign

corporation to claim the portfolio interest exemption, and thus not be subject to

withholding procedures, it generally must receive a statement that the beneficial

owner of the registered obligation is not a U.S. person. See secs. 871(h)(5),

881(c)(2)(B); sec. 1.881-2(a)(6), Income Tax Regs. (referring to section 1.871-14,

Income Tax Regs., for rules applicable to a foreign corporation’s receipt of interest

on certain portfolio debt instruments); sec. 1.871-14(c)(1)(ii), Income Tax Regs.

(applicable to interest payments made after December 31, 2000). A debtor that

does not have a beneficial ownership statement before the interest payment must

rely on presumption rules in the regulations to determine whether to withhold

under section 1442. See sec. 1.871-14(c)(3)(i), Income Tax Regs. (applicable to

interest payments made after December 31, 2000); sec. 1.1442-1, Income Tax
                                       - 33 -

[*33] Regs. (referring to sections 1.1441-1 through 1.1441-9, Income Tax Regs.,

for rules concerning the withholding of tax at the source in the case of foreign

corporations); sec. 1.1441-1(b)(7)(i), Income Tax Regs. (applicable to interest

payments made after December 31, 2000).

      For interest payments made in tax years 1995-2000, this statement must be

signed by the beneficial owner under penalty of perjury and provide the name and

address of the beneficial owner. Sec. 35a.9999-5(b), Q&A-9, Temporary Income

Tax Regs., 49 Fed. Reg. 33242 (Aug. 22, 1984). For interest payments made after

December 31, 2000, this statement has the added requirement that it must be

provided every three years during the period in which the beneficial owner owns

the obligation. See secs. 871(h)(5), 881(c)(2)(B); sec. 1.871-14(e)(4)(ii), Income

Tax Regs.

      A properly completed Form W-8 will satisfy the requirements under section

871(h)(5). See sec. 35a.9999-5(b), Q&A-9, Temporary Income Tax Regs., supra;

secs. 1.871-14(c)(2)(i), 1.1441-1(e)(1)(ii)(1), (2)(ii), Income Tax Regs. For

interest payments made in tax years 1995-2000, the Form W-8 must be received by

the payor in the calendar year in which the payment is made or collected or in

either of the preceding two calendar years. Sec. 35a.9999-5(b), Q&A-9,

Temporary Income Tax Regs., supra; sec. 1.6049-5(b)(2)(iv), Income Tax Regs.
                                             - 34 -

[*34] For interest payments made after December 31, 2000, the Form W-8 must be

provided before the expiration of the beneficial owner’s period of limitation for

claiming a refund of tax on such interest. See sec. 1.871-14(c)(3)(i) and (ii),

Income Tax Regs. In these cases a Form W-8 had to be provided before the

expiration of Lausanne’s period of limitation for claiming a refund in order for the

interest to qualify as portfolio interest.

      The parties agree that the promissory note purported to be a debt obligation

and was in registered form. The parties do not argue that the presumption rules in

the regulations permit Heimdal to avoid withholding obligations under section

1442. Therefore, for interest payments on the note to be classified as portfolio

interest, Heimdal must have received a statement from Lausanne stating that

Lausanne is not a U.S. person. Heimdal received only one proper Form W-8 from

Lausanne that was issued in 1992. This statement of beneficial ownership would

have been effective only during taxable years 1992-94. See 35a.9999-5(b), Q&A-

9, Temporary Income Tax Regs., supra; sec. 1.6049-5(b)(2)(iv), Income Tax Regs.

      Heimdal also provided an unsigned Form W-8ECI, Certificate of Foreign

Person’s Claim That Income Is Effectively Connected With the Conduct of a

Trade or Business in the United States. Irrespective of whether the Form W-8ECI

has any impact on these cases, the regulations state that a beneficial ownership
                                        - 35 -

[*35] form is valid only if it is signed under penalty of perjury by the beneficial

owner, in these cases Lausanne. Therefore, we cannot rely on this document as a

statement of beneficial ownership.

       Finally, Lausanne’s period of limitation for claiming a refund for any of the

years in issue has expired. See sec. 6511(a) (providing that the period of

limitation for claiming a refund is generally within three years from the time the

return was filed or two years from the time the tax was paid, whichever period

expires later). Therefore, the time for Heimdal to receive a proper beneficial

ownership statement has run out. Thus, for the years in issue, Heimdal did not

satisfy the reporting requirement for claiming the portfolio interest exemption.

       C.    Conclusion

       In conclusion we hold that Heimdal’s payments to Lausanne were not bona

fide interest payments. Therefore, the Norse Group is not entitled to deduct a

purported interest expense of $7,229,930 for the 2007 tax year, and Heimdal is

liable for a 30% withholding tax on the gross amount of distributions it made to

Lausanne for the years in issue.

III.   Penalty and Additions to Tax

       Respondent determined that the Norse Group is liable for the section

6662(a) accuracy-related penalty on its underpayment for the 2007 tax year.
                                        - 36 -

[*36] Respondent also determined that Heimdal is liable for additions to tax under

sections 6651(a)(1) and (2) and 6656 for tax years 1995-2008. Respondent now

concedes that Heimdal is not liable for the section 6651(a)(2) additions to tax.

      A.     The Norse Group

      Section 6662(a) and (b)(2) imposes a 20% accuracy-related penalty on any

underpayment of Federal income tax which is attributable to a substantial

understatement of income tax. In the case of a corporation (other than an S

corporation or a personal holding company), an understatement of income tax is

substantial if it exceeds the lesser of 10% of the tax required to be shown on the

return (or, if greater, $10,000) or $10 million. Sec. 6662(d)(1)(B). The Norse

Group, as a corporate taxpayer, bears the burden of proving that it is not liable for

an accuracy-related penalty pursuant to section 6662(a). See NT, Inc. v.

Commissioner, 126 T.C. 191, 195 (2006).

      The taxpayer must come forward with persuasive evidence that the penalty

is inappropriate because, for example, the taxpayer acted with reasonable cause

and in good faith. Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 448-449.

The decision as to whether a taxpayer acted with reasonable cause and in good

faith is made on a case-by-case basis, taking into account all of the pertinent facts

and circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs.
                                        - 37 -

[*37] Reliance on the advice of a tax professional may, but does not necessarily,

establish reasonable cause and good faith for the purpose of avoiding a section

6662(a) penalty. United States v. Boyle, 469 U.S. 241, 251 (1985) (“Reliance by a

lay person on a lawyer [or an accountant] is of course common; but that reliance

cannot function as a substitute for compliance with an unambiguous statute.”).

That petitioners had an accountant prepare their returns does not, in and of itself,

prove that they acted with reasonable cause and in good faith. See Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. 43, 99-100 (2000), aff’d, 299 F.3d 221

(3d Cir. 2002).

      Caselaw sets forth the following three requirements in order for a taxpayer

to use reliance on a tax professional to avoid liability for a section 6662(a)

penalty: “(1) The adviser was a competent professional who had sufficient

expertise to justify reliance, (2) the taxpayer provided necessary and accurate

information to the adviser, and (3) the taxpayer actually relied in good faith on the

adviser’s judgment.” See id. at 99; see also Charlotte’s Office Boutique, Inc. v.

Commissioner, 425 F.3d 1203, 1212 n.8 (9th Cir. 2005) (quoting with approval

the above three-prong test), aff’g 121 T.C. 89 (2003). In addition, the advice must

not be based on unreasonable factual or legal assumptions (including assumptions

as to future events) and must not unreasonably rely on the representations,
                                        - 38 -

[*38] statements, findings, or agreements of the taxpayer or any other person. Sec.

1.6664-4(c)(1)(ii), Income Tax Regs.

      The Norse Group reported tax of $1,817,192 on its 2007 return while it was

required to show tax of $5,578,506, notwithstanding certain deductions. This

understatement exceeds $557,850 (10% of the required tax to be shown on Norse

Group’s return), an amount which is the lesser of $10 million (and the greater of

$10,000). Therefore, the understatement of income tax was substantial.

      The Norse Group argues that it had substantial authority for its position to

treat its disbursements to Lausanne as interest payments. It also argues that it

acted with reasonable cause and in good faith with respect to this position because

it relied on Pfaff’s advice.

      As explained above, the arguments the Norse Group offered to show

support for its position are not adequately supported by the caselaw and do not

show substantial authority. See sec. 1.6662-4(d)(2) and (3), Income Tax Regs.

The position the Norse Group took on its 2007 tax return was a gamble at best as

the weight of the authorities supporting its treatment of the disbursements to

Lausanne as interest payments was slim to none while the weight of the authorities

supporting contrary treatment was abundant. See id.
                                        - 39 -

[*39] Furthermore, the Norse Group’s argument that it relied on the advice of a

competent tax professional is not persuasive. While Pfaff assisted in the

development of the transaction between Heimdal and Lausanne, the Norse Group

failed to follow his recommendations of obtaining a valuation of the CG units or

filing the requisite forms to claim the portfolio interest exemption. Additionally,

Pfaff’s suggestions were informal and not up to the strict standards of his firm’s

opinion letters on which clients could reasonably rely. Heimdal and Lausanne

simply took Pfaff’s recommendations for the design of the transaction at face

value without negotiating the terms. When it came time for Pfaff to write a

memorandum of advice regarding the transaction, it was unclear whether Pfaff’s

memorandum was directed towards the Norse Group, Lausanne, or both. Pfaff’s

multiple correspondence with both the Norse Group and Lausanne shows that the

Norse Group did not use his advice so much for properly assessing their tax

liability as they did for entering into a transaction for pure tax-avoidance purposes.

We conclude that the Norse Group did not act with reasonable cause and in good

faith in deducting its disbursements to Lausanne as interest payments for 2007.

      B.     Heimdal

      Section 6651(a)(1) provides for an addition to tax of 5% of the tax required

to be shown on the return for each month or fraction thereof for which there is a
                                          - 40 -

[*40] failure to file, not to exceed 25%. However, the addition to tax for failure to

file is not imposed if it is shown that the failure to file did not result from willful

neglect and was due to reasonable cause. See Boyle, 469 U.S. at 245. To prove

reasonable cause, the taxpayer must show that he exercised ordinary business care

and prudence but nevertheless could not file the return when it was due. See

Crocker v. Commissioner, 92 T.C. 899, 913 (1989); sec. 301.6651-1(c)(1), Proced.

& Admin. Regs.

       Section 6656 imposes an addition to tax equal to 10% of the portion of an

underpayment in withholding tax that is required to be deposited if the failure to

deposit extends more than 15 days. A taxpayer may also avoid the addition to tax

under section 6656 if its failure to deposit was due to reasonable cause and not

willful neglect. Charlotte’s Office Boutique, Inc. v. Commissioner, 121 T.C. at

109.

       It is undisputed that Heimdal filed no withholding tax returns (Forms 1042)

and deposited no withholding taxes with the Treasury. Heimdal argues that its

failure to file Forms 1042 was due to reasonable cause because: (1) its very

obligation to file the returns is the issue being litigated in these cases, and (2) it

reasonably relied on the advice of a competent tax professional who informed

Heimdal that it had no withholding obligation. This argument fails.
                                         - 41 -

[*41] There is no evidence that Heimdal was told that it need not file Forms 1042.

In fact, there is evidence to the contrary. Pfaff specifically told Heimdal that its

disbursements to Lausanne would be subject to withholding taxes if Heimdal

failed to receive a Form W-8 from Lausanne every three years and failed to attach

each Form W-8 with Form 1042-S to Form 1042. Heimdal did not follow this

important advice. Therefore, Heimdal cannot show that it acted with reasonable

cause and in good faith. Accordingly, we sustain respondent’s determination that

Heimdal is liable for additions to tax and penalties for tax years 1995-2008.

         We have considered all the other arguments made by the parties, and to the

extent not discussed above, find those arguments to be irrelevant, moot, or without

merit.

         To reflect the foregoing,


                                                  Decisions will be entered

                                            under Rule 155.
