                        T.C. Memo. 2000-19



                      UNITED STATES TAX COURT



            KHALIL AND LANA K. HAMDAN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8669-97.                      Filed January 18, 2000.



     Khalil and Lana K. Hamdan, pro sese.

     Ric Hulshoff, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS, Judge: Respondent determined an $88,376 deficiency in

petitioners’ 1989 Federal income tax and a $17,675 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 -

      The deficiency is based on an adjustment to the income of

petitioners’    wholly   owned    S    corporation    and    a   corresponding

increase in petitioners’ distributive share of the S corporation’s

income.    The adjustment stems from the disallowance of: (1) A

deduction for a $300,000 “profit participation fee” purportedly

paid in 1989 by the S corporation to petitioners’ wholly owned C

corporation; and (2) travel and automobile expenses claimed by the

S corporation. (An S corporation’s income is passed through to its

shareholders; thus, the disallowance of deductions claimed by an S

corporation results not only in an increase in the income of the S

corporation     but   also   in   an    increase     in   the    shareholders’

distributive shares of the S corporation’s income.)

      In their petition, petitioners contest the increase to their

distributive share of the S corporation’s 1989 income, as well as

the imposition of the section 6662(a) accuracy-related penalty. By

way   of   an   amendment    to   their   petition,       petitioners   assert

entitlement to a business bad debt deduction in 1990, which, if

petitioners are correct, can be carried back to 1989, the year at

issue.

      Accordingly, the issues for decision are:             (1) The propriety

of the $300,000 “profit participation fee” deduction claimed by

petitioners’ wholly owned S corporation; (2) the propriety of

travel and automobile expense deductions claimed by petitioners’

wholly owned S corporation; (3) whether petitioners’ advances to
                                            - 3 -

their   C    corporation        are    to    be     characterized    as    loans    (as

petitioners    maintain)        or    capital       contributions   (as    respondent

maintains); and if the advances are to be characterized as loans,

further inquiry must be made into (a) whether the loans were

business or nonbusiness debts and (b) whether the loans became

worthless in 1990; and (4) whether petitioners are liable for the

section 6662(a) accuracy-related penalty.

                                  FINDINGS OF FACT

     Some    of    the    facts       have    been    stipulated    and    are   found

accordingly.       The stipulation of facts and the attached exhibits

are incorporated herein by this reference.

Background

     Petitioners, husband and wife, resided in San Juan Capistrano,

California, at the time they filed their petition.

     On September 25, 1990, petitioners filed their 1989 Federal

income tax return.            In February 1993, petitioners and respondent

executed a Form 872-A, Special Consent to Extend the Time to Assess

Tax, with respect to tax year 1989.                  In April 1994, they executed

a Form 872-A with respect to tax year 1990.

Petitioners’ Corporations

     During       the    year    at    issue,        petitioners    were   the     sole

shareholders      of    two    California      corporations:        Hamdan   Project

Development (HPD), formed on May 24, 1984, and HPD-Latigo Corp.

(HPD-Latigo), formed on July 14, 1987.                 Khalil Hamdan (petitioner)

was the president of both corporations.
                                     - 4 -

       For tax purposes:        (1) HPD was a C corporation and reported

its income employing the accrual method of accounting, and (2) HPD-

Latigo was an S corporation and reported its income employing the

cash method of accounting.

       HPD-Latigo had no personnel on its payroll.

Limited Partnership

       Malibu Cedars, Ltd. (Malibu Cedars), is a California limited

partnership formed in 1987 to acquire foreclosed rental property

located in the Latigo Beach area of Malibu, California, and to

convert    that   property       (consisting    of    104   apartments)   into

condominiums (hereinafter the conversion is sometimes referred to

as   the   project   or   the    Malibu   Cedars     project).    Partnership

interests in Malibu Cedars were held as follows:

       General Partners

       HPD-Latigo                            25-percent interest
       Khodor I. Saab                        25-percent interest

       Limited Partner

       Cambridge Financial, Inc.             50-percent interest

       In connection with the project, in July 1987, Malibu Cedars

entered into an Agreement for Services (Agreement) with Plaza-HPD,

a joint venture composed of Plaza Development, Inc. (Plaza) and

HPD.     Plaza was owned 50 percent by Mr. Saab and 50 percent by

Joseph Ghadir.

       The Agreement obligated Plaza-HPD to:            (1) Manage, operate,

maintain, lease, and rent to others the project property until such
                                     - 5 -

time as the units were sold as condominiums; (2) contract with

licensed contractors, architects, consultants, and civil engineers

to renovate, improve, or modify the project property for conversion

and sale of the units as condominium units according to approved

plans     and    permits;   (3)    engage    the    services   of   attorneys,

consultants, management and maintenance companies, accountants, and

others for purchase and management, as well as to obtain necessary

permits and approvals for sale, of the units as condominiums; (4)

enter into agreements with brokers to handle sales of condominium

units;     (5)   contract   with   marketing       companies   to   market   the

condominium units; (6) exercise general supervision regarding those

individuals and companies referred to above; and (7) perform all

other reasonably required tasks to ensure speedy sale of the project

property as condominiums at the optimal price.

     In exchange for these services, Malibu Cedars agreed to pay

Plaza-HPD: (1) A profit participation fee of 40 percent of all cash

proceeds from sales in excess of the total costs the partnership

incurred; and (2) a $750,000 overhead fee over 3 years.               The fees

paid to Plaza-HPD were distributed: HPD--47.5 percent; Plaza--52.5

percent.

        The following chart represents the organizational structure of

the Malibu Cedars project:
                                                   - 6 -


                                                                                     Khalil Hamdan
                                                                                      Lana Hamdan
                                                                                     (petitioners)

                                                                              100%




      K.I. Saab             Cambridge Financial,            HPD - Latigo
     Individual                      Inc.                    Corporation
   General Partner              C Corporation               S Corporation
                               Limited Partner             General Partner




                                  50%                                25%
                                                                                            100%
                      25%


Joseph Ghadir                                 Malibu Cedars, Ltd.
                                               TEFRA Partnership




 50%            50%                       Agreement for Services

                                                Plaza - HPD
                                               Joint Venture


                                  52.5%                             47.5%



                                                                             Hamdan Project Development
 Plaza Development Incorporated                                                      Corporation
                                                                                    C Corporation
                                - 7 -

     By December 31, 1989, Malibu Cedars had sold 96 of the 104

available condominiums.      In terms of square footage sold, this

constituted 86,532 of the 92,621 square feet of available property

for sale (or 93.4 percent of the square feet of property for sale).

The Malibu Cedars project had gross sales in excess of $28 million.

     By December 31, 1989, Malibu Cedars had paid $1,239,750 to HPD,

and $1,370,250 to Plaza in exchange for services rendered pursuant

to the Agreement.   Moreover, as of December 31, 1989, the books of

Malibu Cedars reflected fees payable to HPD of $411,982 and fees

payable to Plaza of $455,349.

     In calculating its costs of goods sold for tax year 1989,

Mailbu Cedars included $600,000 as construction costs, which was

based on an accounting entry (specifically, an adjusted journal

entry) that allocated construction costs on square footage sold

rather than on units sold.       In a Notice of Final Partnership

Administrative Adjustment (FPAA), dated December 20, 1994, issued

to HPD-Latigo, as Malibu Cedars’ tax matters partner, respondent

disallowed for 1989:      (1) The aforementioned $600,000, and (2)

$867,331 of claimed developers’ fees.    (The issues raised in the

FPAA were not raised in the statutory notice of deficiency upon

which this case is based.)   Respondent’s determinations in the FPAA

were contested in this Court, and subsequently conceded, by Malibu

Cedars.   On May 20, 1997, a closing agreement was entered into
                                     - 8 -

between Malibu Cedars and the IRS reflecting this concession.1           The

closing agreement was signed on behalf of Malibu Cedars by “Khalil

Hamdan, H.P.D. Latigo”. On May 29, 1997, the Court entered a

stipulated decision reflecting the concession.2

Profit Participation Fee

      As of December 31, 1989, the records of HPD-Latigo reflected

an accounting entry for a $300,000 account payable to HPD, and the

records of HPD reflected a corresponding accounting entry for a

$300,000    account     receivable   from    HPD-Latigo;   both   of   these

accounting entries related to a “profit participation fee”.

      The purported reason for the $300,000 profit participation fee

was   to   compensate    HPD   for   services    (legal,   accounting,   and

consulting) rendered to HPD-Latigo, including services rendered

prior to HPD-Latigo’s incorporation.            Petitioners perceived HPD-

Latigo to be their “investment arm” and HPD as the “operating arm”

for HPD-Latigo.




      1
          The closing agreement provided that Malibu Cedars,
Ltd., was not required to include in its 1992 income $432,600,
representing developers’ fees that had been accrued and deducted
in 1989 but never paid.
      2
          Petitioners request that we revisit the issues involved
in that case. We decline to do so. See, e.g., Stanko v.
Commissioner, T.C. Memo. 1996-530. The doctrine of res judicata
precludes relitigation of the issues involved therein. Moreover,
the items at issue herein are those of the partner, HPD-Latigo,
not those of the partnership, Malibu Cedars. Consequently, we
have no jurisdiction to redetermine any adjustment to Malibu
Cedars’ partnership return. See Sente Inv. Club Partnership v.
Commissioner, 95 T.C. 243, 247 (1990).
                                     - 9 -

Travel and Automobile Expenses

       For 1989, HPD-Latigo deducted $8,249 as “travel expenses” to

entertain several Saudi investors in Cambridge Financial, Inc., and

their entourage, by taking them to Utah to see summer snow.

Additionally, HPD-Latigo deducted $7,379 in automobile expenses

incurred for the use by the Saudi investors of a limousine (owned

by petitioners) and driver.

Funds Advanced to C Corporation

       Over   the   years,    petitioners    made   advances      to    HPD;    these

advances were made to salvage petitioners’ investment in HPD.

Several of these advances were reflected in the minutes of HPD board

of directors’ meetings, as follows:           (1) On September 1, 1987, the

directors ratified borrowings of $1,688,084.35 from petitioners that

occurred between December 18, 1986, and September 1, 1987.                 Of this

amount, HPD had repaid $395,926.18, and (2) on October 15, 1987, the

directors approved borrowing of $310,000, at an unspecified date,

from   petitioners.      With    respect     to   this    advance,      HPD’s    vice

president executed a note, dated October 15, 1987, for $300,000,

payable in 36 months from the date thereof. No interest was stated.

       HPD repaid only a portion of these advances.                     Apparently

repayment     was   by   an    accounting     entry      (debit    to    “loan    to

stockholders”) rather than the payment of cash.             The balance sheets

of HPD reflect the following balances in the “loan to stockholders”

account:
                                  - 10 -

                Date                              Balance
          Jan. 1, 1989                           $5,596,306
          Dec. 31, 1989                           6,088,816
          Dec. 31, 1990                           4,938,755
          Dec. 31, 1991                           7,810,284
          Dec. 31, 1992                           7,240,802
          Dec. 31, 1993                           7,173,905
          Dec. 31, 1994                      6,873,007
     Petitioners made a series of loans totaling $125,000 to Mr.

Saab in 1989.    On February 11, 1992, Mr. Saab filed a chapter 7

bankruptcy petition, and the loans he owed to petitioners were

discharged.

Tax Returns

     On its 1989 Form 1120, U.S. Corporation Income Tax Return, HPD

reported a $16,972 loss.

     On its 1989 Form 1120S, U.S. Income Tax Return for an S

Corporation, HPD-Latigo reported $1,145,203 as its distributive

share of partnership profits from Malibu Cedars.       (HPD-Latigo had

no other income.)      HPD-Latigo claimed deductions of $610,823 on its

1989 return, as follows: $300,000 as a profit participation fee,

$19,073 as travel expenses, and $291,750 as amortized capitalized

costs.

     On their 1989 Form 1040, U.S. Individual Income Tax Return,

petitioners reported $430,914 as their distributive share of profits

from HPD-Latigo.        Petitioners did not report any interest income

from HPD on either their 1989 or 1990 Federal income tax return.

As of December 31, 1994, neither petitioners nor HPD treated any
                               - 11 -

amount of the funds petitioners advanced to HPD as worthless loans.

The Audit

     In response to Internal Revenue Service inquiries regarding the

$300,000 profit participation fee, petitioners’ accountant explained

in an August 10, 1992, letter, that the fee represented a charge for

services HPD rendered to HPD-Latigo (beginning from HPD-Latigo’s

inception).   With this letter, two undated interoffice memoranda

discussing the $300,000 fee were enclosed.3

Notice of Deficiency

     In the notice of deficiency, respondent increased petitioners’

1989 distributive share of profit arising from HPD-Latigo (based

upon the disallowance of HPD-Latigo’s $300,000 profit participation



     3
          Mr. Hamdan wrote a memorandum on HPD’s behalf, advising
Peter Klaiber, HPD’s executive vice president, that HPD should
charge HPD-Latigo an $100,000 yearly fee for services rendered.
In a second memorandum, Mr. Klaiber advised Mr. Hamdan that an
$100,000 yearly fee would be “reasonable”, and would cover
compensation for services HPD rendered regarding HPD-Latigo’s
formation. Mr. Klaiber listed the services to be rendered, among
others, as follows:

     01. A compensation towards the formation of the
     corporation:

                 Legal, Accounting and Tax Consultation;
            Federal and State Registration; Incorporation
            Certification; Notarization; Publication and
            other similar matters.

     02. A compensation towards the running of the
     corporation:

                 Outside Legal, Accounting and Tax
            Service; Internal Maintenance of Accounting
            and Tax Records; General and Administrative
            Service; and other similar matters.
                                  - 12 -

fee deduction for that year).          The notice of deficiency also

disallowed petitioners’ flow-through deductions of $8,249 in travel

expenses and $7,379 in automobile expenses.4

                                 OPINION

     First, we must deal with petitioners’ limitations argument.

Petitioners assert that the notice of deficiency is invalid because

respondent failed to secure an extension of time from petitioners’

S corporation (HPD-Latigo) for 1989.

     When deficiencies result pursuant to a taxpayer’s status as a

shareholder in an S corporation, it is the taxpayer’s return, not

that of the S corporation, that is determinative for section

6501(c)(4) purposes. See Bufferd v. Commissioner, 506 U.S. 523, 533

(1993).    Petitioners and respondent entered into an agreement (Form

872-A) to extend the time to assess petitioners’ 1989 taxes.         The

notice of deficiency was issued prior to a termination of that

agreement.      Accordingly,     we   reject   petitioners’   limitations

argument.

Issue 1.    Profit Participation Fee

     We now turn our attention to the propriety of the $300,000

profit     participation   fee    deduction    claimed   by   HPD-Latigo.

Respondent disallowed this deduction on the basis that petitioners

failed to establish “that the amount [was] incurred or, if incurred,


     4
          On HPD-Latigo’s 1989 return, $19,073 was listed as
travel. The $19,073 comprised $8,249 in travel expenses, $7,379
in automobile expenses, and $3,445 for services rendered by an
accounting firm. Respondent allowed the $3,445 for accounting
services.
                               - 13 -

paid by you during the taxable year for ordinary and necessary

business purposes.”

     It is axiomatic that a taxpayer does not have an inherent right

to take tax deductions.    Deductions are a matter of legislative

grace, and a taxpayer must show that the deduction sought comes

within the express provisions of the statute.   See INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992).    Section 162(a) provides a

deduction for all ordinary and necessary expenses paid or incurred

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

cash basis taxpayer is entitled to a deduction for such expenses in

the year actually paid. See sec. 461(a); sec. 1.461-1(a)(1), Income

Tax Regs.   We look to whether a “hardheaded” businessperson, under

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

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

1972-177.

     At the outset, we are mindful that HPD-Latigo employed the cash

method of accounting.   The profit participation fee was not paid in

cash, but rather through an accounting entry–-an adjusted journal

entry.   Assuming arguendo that the fee was paid in 1989, we agree

with respondent that the fee is not deductible because there has

been no showing that the fee constituted an ordinary and necessary

business expense.

     First, there was no written agreement reflecting that HPD was

to provide services to HPD-Latigo.      The two undated memoranda

petitioners introduced into evidence are suspect and not reliable.
                                          - 14 -

        Second, we are not satisfied that HPD performed services for

HPD-Latigo. Hence, there is no perceptible business purpose or

economic justification for the profit participation fee.

      Third, by directing the S corporation (HPD-Latigo) to show an

account payable of $300,000 to the C corporation (HPD), the profits

of   the      S    corporation      decreased      and   were    moved   into   the   C

corporation, which was running at a loss.                 We agree with respondent

that the profit participation fee was but a fabrication, primarily,

if not solely, engineered to shift income between related entities

in order to minimize petitioners’ (and their wholly owned entities’)

overall tax obligation.               Consequently, we conclude respondent

properly disallowed the claimed $300,000 profit participation fee,

which    in       turn   resulted    in   an    increase    in    petitioners’   1989

distributive share of profits from HPD-Latigo.

Issue 2.          Travel and Automobile Expenses

        The next issue is whether HPD-Latigo is entitled to a $8,249

deduction for travel expenses and a $7,379 deduction for automobile

expenses.

        Section 162(a) allows a taxpayer to deduct “all the ordinary

and necessary expenses paid or incurred * * * in carrying on any

trade or business”.           A taxpayer must substantiate any deduction

claimed.          See Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975),

affd. per curiam 540 F.2d 821 (5th Cir. 1976).                    In substantiating

deductions, taxpayers are required to maintain adequate records

sufficient to enable the Commissioner to determine the taxpayer’s
                                      - 15 -

correct tax liability.         See Meneguzzo v. Commissioner, 43 T.C. 824,

831-832 (1965). Section 274(d) provides that no deduction or credit

will be allowed for any traveling expense or for any activity that

is of a type generally considered to constitute entertainment,

amusement, or recreation “unless the taxpayer substantiates by

adequate   records      or   by   sufficient     evidence      corroborating     the

taxpayer’s own statement”.

      Petitioners failed to establish their entitlement to the travel

and   automobile     expense       deductions.       They    failed     to   produce

contemporaneous logs documenting the expenses; they produced only

a few canceled checks and receipts that for the most part documented

purchases of women’s sportswear and travel in Europe.

      In sum, petitioners have failed to satisfy the requirements of

sections   162    and   274.       Accordingly,      we     sustain    respondent’s

determination on this issue.

Issue 3.   Loans vs. Capital Contributions

      The next issue is whether petitioners’ advances to HPD are to

be characterized as loans or capital contributions. If we determine

the advances to be loans, further inquiry must be made into whether

the loans were business or nonbusiness debts and whether they became

worthless.5      Respondent       contends     the    advances        were   capital


      5
          Petitioners claim they are entitled to a bad debt
deduction in 1990 with respect to funds they advanced to HPD.
Petitioners assert that the bad debt deduction created a net
operating loss, which they seek to carry back to 1989 under sec.
172. We have jurisdiction over those items in years that bear on
a taxpayers’ tax liability for the year at issue. See sec.
                                                   (continued...)
                               - 16 -

contributions. Petitioners argue that they were loans and that they

are entitled to a $357,557 bad debt deduction for 1990 (which can

be carried back to 1989, the year at issue), calculated as follows:

     HPD’s negative retained earnings            ($1,357,557)
     HPD’s capital stock                           1,000,000

          1990 bad debt                              357,557

     Generally, taxpayers may deduct the value of bona fide debts

owed to them that become worthless during the year.         See sec.

166(a).   Bona fide debts generally arise from valid debtor-creditor

relationships reflecting enforceable and unconditional obligations

to repay fixed sums of money. See sec. 1.166-1(c), Income Tax Regs.

For section 166 purposes, contributions to capital do not constitute

bona fide debts.   See Kean v. Commissioner, 91 T.C. 575, 594 (1988).

The burden of establishing that the advances were loans rather than

capital contributions rests with the taxpayers.     See Rule 142(a).

     Courts look to the following nonexclusive factors to evaluate

the nature of transfers of funds to closely held corporations: (1)

The names given to the documents evidencing the indebtedness; (2)

the presence or absence of a maturity date; (3) the source of

repayments; (4) the right to enforce repayment of principal and

interest; (5) participation in management; (6) whether the taxpayers



     5
     (...continued)
6213(a); Rule 13(a); Calumet Ind. v. Commissioner, 95 T.C. 257,
274 (1990) (citing Lone Manor Farms, Inc. v. Commissioner, 61
T.C. 436, 440 (1974), affd. without published opinion 510 F.2d
970 (3d Cir. 1975)). Thus, we have jurisdiction to determine
whether petitioners are entitled to a bad debt deduction in 1990
and are entitled to a net operating loss carryback to 1989.
                              - 17 -

subordinated their purported loans to the loans of the corporation’s

regular creditors; (7) the intent of the parties; (8) “thin” or

adequate capitalization; (9) identity of interest between creditor

and stockholder; (10) payment of interest only out of “dividend”

money; and (11) the ability of the corporation to obtain financing

from outside sources at the time of the transfers. See, e.g., Bauer

v. Commissioner, 748 F.2d 1365, 1368 (9th Cir. 1984); Dixie Dairies

Corp. v. Commissioner, 74 T.C. 476, 493 (1980).      As among these

factors “No one factor is controlling or decisive, and the court

must look to the particular circumstances of each case”, for “The

object of the inquiry is not to count factors, but to evaluate

them.”   Bauer v. Commissioner, supra at 1368 (quoting Tyler v.

Tomlinson, 414 F.2d 844, 848 (5th Cir. 1969)).6


     6
          As we stated in Dixie Dairies Corp. v. Commissioner, 74
T.C. 476, 493-494 (1980):

                The identified factors are not equally
           significant, * * * nor is any single factor
           determinative. Moreover, due to the myriad
           factual circumstances under which debt-equity
           questions can arise, all of the factors are
           not relevant to each case. 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.” * * * “The various factors * * *
           are only aids in answering the ultimate
           question whether the investment, analyzed in
           terms of its economic reality, constitutes
           risk capital entirely subject to the fortunes
           of the corporate venture or represents a
           strict debtor-creditor relationship.” * * *
           As expressed by this Court, the ultimate
           question is “Was there a genuine intention to
           create a debt, with a reasonable expectation
                                                    (continued...)
                                      - 18 -

     Moreover, transfers to closely held corporations by controlling

shareholders are subject to heightened scrutiny.               Labels attached

to   such   transfers    by     the    controlling    shareholders      through

bookkeeping entries or testimony have limited significance unless

these labels are supported by objective evidence.                   See Fin Hay

Realty Co. v. United States, 398 F.2d 694, 697 (3d Cir. 1968);

Goodrich v. Commissioner, T.C. Memo. 1997-194.                “Courts will not

tolerate    the   use   of    mere     formalisms    solely    to    alter   tax

liabilities.”     Hardman v. United States, 827 F.2d 1409, 1411 (9th

Cir. 1987) (quoting Commissioner v. Court Holding Co., 324 U.S. 331,

334 (1945)).

     After careful consideration of the facts and circumstances

surrounding petitioners’ advances to HPD and utilizing some of the

factors noted above in addition to others, we conclude that the

advances are capital contributions, not loans.

     First, petitioners advanced money to HPD, their wholly owned

C corporation, without intent that such advances be treated as debt

rather than equity.     Not engaged in the business of lending money,

petitioners made the advances simply because the corporation needed

the cash to survive.         According to petitioner, the advances were

made in order to “salvage” petitioners’ investment because capital



     6
      (...continued)
           of repayment, and did that intention comport
           with the economic reality of creating a
           debtor-creditor relationship?” [Citations
           omitted.]
                                      - 19 -

and funds they had previously advanced to the corporation were in

peril.

       Second, petitioners have not shown that HPD could have obtained

financing      from   an   outside    lender.   That   HPD   had    to    look   to

petitioners in order to survive is evidence that the advances were

capital contributions and not loans. HPD’s financial situation grew

worse, and yet petitioners continued to advance funds.              HPD did not

seek   funds    elsewhere.      The    only    apparent   means    of    obtaining

financing for HPD was that utilized herein.               We conclude that an

independent commercial lender would not have lent funds to HPD under

these circumstances.

       Third, the documentary evidence regarding the purported loans

is sparse.      Other than the $310,000 promissory note7 referenced in

the    October 15, 1987, board of directors meeting minutes, HPD did

not execute any notes, or issue to petitioners any negotiable

instruments, evidencing an obligation to repay amounts petitioners

advanced to the corporation.             The absence of notes or other


       7
          Petitioner testified that in addition to the $310,000
note in evidence, all other advances petitioners made to HPD were
memorialized in promissory notes; however, petitioners failed to
offer them into evidence. In such situations, we have noted:

       The rule is well established that the failure of a
       party to introduce evidence within his possession and
       which, if true, would be favorable to him, gives rise
       to the presumption that if produced it would be
       unfavorable. [Citations omitted.] This is especially
       true where, as here, the party failing to produce the
       evidence has the burden of proof * * *

Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947).
                                 - 20 -

instruments favors respondent.         See Calumet Ind. v. Commissioner,

95 T.C. 257, 274 (1990).

     Fourth, no terms were provided for repayment, and the sole

promissory note in evidence does not provide for an interest rate

or interest payments.    HPD made repayments depending upon its cash

position and liquidity; however, the repayments never kept up with

the advances.     “If the expectation of repayment depends solely on

the success of the borrower’s business, the transaction has the

appearance of a capital contribution.”           Roth Steel Tube Co. v.

Commissioner, 800 F.2d 625, 631 (6th Cir. 1986), affg. T.C. Memo.

1985-58.   Moreover, petitioner testified that he would not enforce

repayment of the advances, but instead HPD only had to repay the

advances when it could.     Petitioners’ failure to demand repayment

and their continued lending of additional funds tend to refute the

existence of a valid debtor-creditor relationship. See, e.g.,

Boatner    v.   Commissioner,   T.C.    Memo.   1997-379,   affd.   without

published opinion 164 F.3d 629 (9th Cir. 1998).

     Petitioners seek to find comfort in the fact that a portion of

their advances was recorded as loans on the corporation’s books and

records.    However, we are not convinced that this fact entitled

petitioners to enforce payment of principal or interest.            Rather,

we believe the recordation was merely a bookkeeping entry of little

value without the support of other objective criteria.          See Dixie

Dairies Corp. v. Commissioner, 74 T.C. at 495.

     Finally, petitioners admit that HPD did not give any security
                                 - 21 -

or execute any security agreements to collaterize the advances.

According to petitioners, security for the alleged loans was “not

needed especially when petitioners are the sole owners and the CEO

of HPD with full control of its finances”.

     In sum, on the basis of the facts and circumstances, we

conclude that petitioners did not intend to create bona fide loans

at the time the advances were made.         Rather, in an attempt to

salvage HPD (as petitioner admitted at trial), petitioners advanced

funds to the corporation when necessary, so far as the evidence

shows, without the intention of being creditors.         We hold that the

advances were capital contributions. Consequently, petitioners are

not entitled to a bad debt deduction pursuant to section 166.         In

view of this holding, we need not decide (a) whether the advances

were business or nonbusiness bad debts and/or (b) whether the

advances became worthless in 1990.

Issue 4.    Section 6662(a) Accuracy-Related Penalty

     The final issue is whether petitioners are liable for the

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

accuracy-related penalty equal to 20 percent of any portion of an

understatement attributable to negligence or disregard of rules or

regulations or substantial understatement of tax.           “Negligence”

means any failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code, and “disregard” means any

careless,    reckless,   or   intentional   disregard.    Sec.   6662(c).

Additionally, no penalty is imposed with respect to any portion of
                                   - 22 -

an understatement as to which the taxpayer acted with reasonable

cause and in good faith.      See sec. 6664(c)(1).

     Petitioners failed to establish that they were not negligent.

In claiming the deductions at issue, they failed to follow the rules

and regulations either because they failed to determine what the

rules require, or they acted in disregard of them.           Petitioners,

through    HPD-Latigo,     improperly    attempted   to    use   a   profit

participation   fee   in   order   to   decrease   their   tax   liability.

Petitioners also failed to maintain adequate records or otherwise

substantiate the alleged travel and automobile deductions. Finally,

petitioners failed to offer any evidence that they should not be

subject to the accuracy-related penalty.      Accordingly, we hold that

petitioners are liable for the section 6662(a) accuracy-related

penalty.

     In reaching our conclusions herein, we have considered all

arguments presented and, to the extent not discussed above, find

them to be irrelevant or without merit.       To reflect the foregoing,



                                                       Decision will be

                                               entered for respondent.
