                        T.C. Memo 1999-411


                      UNITED STATES TAX COURT



         DEL COMMERCIAL PROPERTIES, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 1887-98.            Filed December 20, 1999.



     Val J. Albright, for petitioner.

     George E. Gasper, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:   For 1990 through 1993, respondent

determined deficiencies in petitioner’s Federal income taxes and

additions to tax as follows:
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                                       Additions to Tax
      Year     Deficiency        Sec. 6651(a)(1)    Sec. 6656

      1990      $  5,823            $     1,456         $   582
      1991       136,238                 34,060          13,624
      1992       479,445                119,861          47,945
      1993       265,732                 66,433          26,573


     Unless otherwise indicated, all section references are to

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

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     After concessions, the issues for decision are whether,

under sections 894, 1441, and 1442 and under a treaty between the

United States and Canada, interest paid by petitioner is subject

to withholding tax and whether petitioner is liable for additions

to tax for failure to timely file withholding tax returns and for

failure to make deposit of withholding taxes.


                           FINDINGS OF FACT

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

     At the time the petition was filed, petitioner’s principal

place of business was located in Ontario, Canada.       Petitioner

(Del Commercial) was incorporated in the State of Illinois.         Del

Commercial invested in and owned industrial real property located

in the United States and leased the property to tenants.

     In 1990, Del Commercial participated in a series of related

and essentially simultaneous financial transactions with a number

of its affiliated foreign corporations.       As set forth in the
                                      - 3 -

chart below, Del Commercial was a fourth-tier subsidiary of the

affiliated group of corporations.           For each of the affiliated

corporations reflected in the chart below, we indicate the name

of the corporation and in parentheses the place of incorporation.

Unless qualified in the footnote to the chart, each arrow

reflects 100-percent ownership and voting control of each lower

level corporation.




   *   With regard to Delcom Properties, Inc., Rayel Construction Ltd., and Tridel
       Corp., the evidence suggests the possibility of some minority ownership. For
       1991 and subsequent years, Rayel Construction Ltd. owned 63.5 percent of La
       Habra Developments Ltd., and Delcom Holdings Ltd. owned the remaining 36.5
       percent.
                               - 4 -

    Tridel Corp. (Tridel) provided overall management and

planning for all of the affiliated corporations.

    In 1990, Del Commercial needed funds to refinance and to make

improvements to some of its real property located in the United

States.   In order to obtain the necessary funds, officers of

Tridel, acting on advice of an accounting firm, initiated and

planned the following essentially simultaneous transactions.

    On July 18, 1990, the Royal Bank of Canada (Royal Bank), an

independent Canadian commercial bank, lent $14 million1 to Delcom

Financial Ltd. (Delcom Financial) at an interest rate based on a

specified bank prime interest rate plus one-half percent per

annum, payable in 20 approximately equal quarterly installments

due in full on July 15, 1995 (Royal Bank loan).

    On July 18, 1990, Delcom Financial purportedly made an

unsecured loan to Delcom Holdings Ltd. (Delcom Holdings) in the

principal amount of $14 million at the same bank prime interest

rate plus five-eights percent per annum.   Delcom Holdings issued

a promissory note to Delcom Financial in exchange for the

purported loan.

    On July 18, 1990, Delcom Holdings purportedly contributed $14

million to Delcom Cayman Ltd. (Delcom Cayman) in exchange for

common shares of stock in Delcom Cayman.   Delcom Cayman then

purportedly contributed $14 million to Delcom Antilles N.V.


1
     All references to dollars are to U.S. dollars.
                               - 5 -

(Delcom Antilles) in exchange for common shares of stock in

Delcom Antilles, and Delcom Antilles purportedly contributed $14

million to Del Investments Netherlands B.V. (Del Netherlands) in

exchange for common shares of stock in Del Netherlands.   Del

Netherlands also executed a written guaranty that guaranteed

repayment of the $14 million Royal Bank loan.

     Del Netherlands maintained a small office in Barbados with

one part-time officer who did not have any substantive duties or

responsibilities.   Other than a few purported loans to members of

the affiliated group of corporations, Del Netherlands conducted

minimal business activity and had negligible assets and

consequently had no independent credit standing outside the

affiliated group of corporations.

    On July 19, 1990, as an integral part of and dependent upon

the above transactions that occurred on July 18, 1990, Del

Netherlands purportedly lent $14 million to Del Commercial.     This

purported loan was reflected by a demand promissory note of Del

Commercial in favor of Del Netherlands with stated interest at a

specified bank prime interest rate plus 1½ percent per annum,

payable in 20 quarterly installments and due in full on July 15,

2015.2   As part of this transaction, a security agreement and a




2
     Del Commercial’s promissory note indicates that some
interest was to be paid monthly.
                                 - 6 -

general assignment of rents were entered into between Del

Commercial and Del Netherlands.

   Also as security for the $14 million Royal Bank loan, Del

Commercial executed a document labeled "Undertaking" which

reflected Del Commercial’s obligation to allow Royal Bank to

place a mortgage on Del Commercial’s real property located in the

United States, and it required Del Commercial to provide to Royal

Bank annual financial statements, to insure its real property, to

assign the insurance policies to Royal Bank, to defer paying

dividends to shareholders, and to pay to Royal Bank on the $14

million Royal Bank loan proceeds from sale of any of Del

Commercial’s real property.

   On January 1, 1991, Del Commercial began making payments on

the $14 million loan Del Commercial purportedly had received from

Del Netherlands.    In each year from 1991 to 1993, Del Commercial

made the following total payments on the $14 million loan it had

received:


        Year       Principal    Interest     Total Payments
        1991       $ 28,062    $ 881,938       $ 910,000
        1992        442,329     3,153,283       3,595,612
        1993        866,998     1,683,002       2,550,000


Del Commercial and Del Netherlands recorded the loan payments on

their respective books and records as having been made by Del

Commercial to Del Netherlands.
                               - 7 -

   For 1991 through June 1992, Del Netherlands transferred the

funds received from Del Commercial either to Delcom Holdings or

to Delcom Financial.   The funds were used to pay principal and

interest owed on the $14 million Royal Bank loan.

   In July of 1992, because of concern of Royal Bank over

payments due on its $14 million loan, Del Commercial began to

make the loan payments due on the loan it had purportedly

received from Del Netherlands directly to Delcom Financial,

bypassing Del Netherlands and Delcom Holdings, and Delcom

Financial then forwarded funds to Royal Bank in payment on the

Royal Bank loan.   On Del Commercial’s books and records, those

loan payments were still recorded as having been made to Del

Netherlands.

   On December 4, 1992, Delcom Financial and Royal Bank amended

the terms of the original $14 million Royal Bank loan.   The

amendment, among other things, increased the interest rate

charged on the loan by 1 percent.   Also, under the amended loan

agreement, Tridel added its guaranty on the Royal Bank loan.

   For 1990 through 1993, Del Commercial did not file U.S.

Federal withholding tax returns with respect to the interest

payments in issue.

   On audit, respondent determined that the substance of the $14

million loan to Del Commercial reflected a loan not from Del

Netherlands, but from Delcom Financial, and therefore that the
                               - 8 -

interest payments Del Commercial made on the loan should be

treated as having been made by Del Commercial to Delcom Financial

and as subject to withholding tax.


                              OPINION

   Under section 881(a), foreign corporations which receive

interest income from U.S. payors (that is not effectively

connected with conduct of a trade or business within the United

States) are liable for a tax of 30 percent of the interest

received.   U.S. taxpayers who pay the interest to the foreign

corporations generally are required to withhold the 30-percent

tax from interest payments made to the foreign corporations.      See

secs. 1441 and 1442.   U.S. taxpayers who are required to withhold

the 30-percent tax and who fail to do so become personally liable

for the withholding tax.   See sec. 1461.

   Under section 894, U.S. treaty provisions may modify the

Internal Revenue Code, including the withholding tax provisions.

For the years at issue, under a treaty between the United States

and Canada (U.S.-Canada Treaty), interest payments made by U.S.

taxpayers to Canadian corporations are subject to tax at a rate

not exceeding 15 percent if the Canadian corporations are the

beneficial recipients and owners of the interest income.    See

Convention on Taxes on Income and Capital, Sept. 26, 1980, U.S.-

Can., art. XI, T.I.A.S. No. 11087.
                                - 9 -

   Also, under a treaty between the United States and the

Netherlands (U.S.-Netherlands Treaty), interest payments made by

U.S. taxpayers to Netherlands corporations are exempt from tax by

the United States.   See Supplementary Convention on Taxes on

Income and Other Taxes, Dec. 30, 1965, U.S.-Neth., art. VI, 17

U.S.T. 896, 901.

   U.S. tax laws and treaties, however, do not recognize as

valid for tax purposes sham transactions or transactions that

have no economic substance.    See Gregory v. Helvering, 293 U.S.

465, 470 (1935); Johansson v. United States, 336 F.2d 809, 813

(5th Cir. 1964).   Even legitimate corporations may engage in sham

transactions.   See Knetsch v. United States, 364 U.S. 361, 366

(1960).

   Also, under various applications of the step-transaction

doctrine, a series of formally separate steps may be collapsed

and treated as a single transaction.    See Penrod v. Commissioner,

88 T.C. 1415, 1428 (1987).    A series of steps may be collapsed

and treated as one if at the time the first step was entered into

there was a binding commitment to undertake the later step

(binding-commitment test), if separate steps constitute

prearranged parts of a single transaction intended to reach an

end result (end-result test), or if separate steps are so

interdependent that the legal relations created by one step would
                             - 10 -

have been fruitless without a completion of the series of steps

(mutual-interdependence test).   See id. at 1429-1430; Custom

Chrome, Inc. v. Commissioner, T.C. Memo. 1998-317, on appeal

(9th Cir., Nov. 9, 1998).

   We have applied the step-transaction doctrine to disregard

the use of intermediaries and conduits for Federal tax purposes.

See Packard v. Commissioner, 85 T.C. 397, 420 (1985); D’Angelo

Associates, Inc. v. Commissioner, 70 T.C. 121, 129 (1978); Gaw v.

Commissioner, T.C. Memo. 1995-531, affd. without published

opinion 111 F.3d 962 (D.C. Cir. 1997).

   Back-to-back loans similar to those involved herein between

U.S. corporations and related foreign corporations and between

the foreign corporations and their indirect foreign parent

corporations have been held to represent mere conduits for the

passage of interest payments, and in such situations we have

imposed withholding tax liability on the U.S. corporate payors.

See Aiken Indus., Inc. v. Commissioner, 56 T.C. 925, 934 (1971).

   Respondent argues that in substance the interest payments in

issue made by Del Commercial were paid to Delcom Financial, a

Canadian taxpayer, with regard to the $14 million Royal Bank loan

and therefore that Del Commercial, under the U.S.-Canada Treaty,

is liable for a 15-percent withholding tax on the interest

payments.
                              - 11 -

   Del Commercial argues that the interest payments were made to

Del Netherlands, a Netherlands corporation, and therefore that

under the U.S.-Netherlands Treaty the interest payments are

exempt from U.S. withholding tax.

   Regardless of which theory is used under the step-transaction

doctrine, the facts in this case result in the same conclusion.

The facts reflect a step transaction created simply to bypass

U.S. withholding tax.   Del Netherlands had minimal assets, and

Del Netherlands had only transitory possession of and no control

over the $14 million loan proceeds as the proceeds were passed

from Delcom Financial to Del Commercial.   Apart from the

purported $14 million loan to Del Commercial, Del Netherlands

engaged in minimal business activity, and the Barbados branch of

Del Netherlands had no officer with any substantive duties or

responsibilities.

   Royal Bank, the independent third-party lender which

ultimately provided the $14 million, exacted guaranties from Del

Commercial and mortgages or deeds of trust on Del Commercial’s

U.S. real property, establishing the link between the loan

payments Del Commercial made and the Royal Bank loan.   Del

Netherlands passed on the loan payments received from Del

Commercial to its affiliated Canadian corporations in order to

service the $14 million Royal Bank loan.   After July of 1992, Del

Commercial bypassed Del Netherlands completely and made the loan
                              - 12 -

payments directly to Delcom Financial.   Del Netherlands acted as

a mere shell or conduit with respect to the interest payments Del

Commercial made.   In substance, Del Commercial received the $14

million loan from Delcom Financial and made the loan payments to

Delcom Financial, a Canadian corporation.   Del Commercial

therefore is liable for the withholding taxes determined by

respondent.

   Northern Ind. Pub. Serv. Co. v. Commissioner, 105 T.C. 341

(1995), affd. 115 F.3d 506 (7th Cir. 1997), on which Del

Commercial relies, is distinguishable.   That case involved a loan

to a U.S. corporation from a foreign subsidiary corporation using

funds obtained from unrelated parties on the Eurobond market.    In

the transaction at issue in the instant case, the participation

of Del Netherlands had no purpose other than avoidance of

withholding tax.   Even the interest-rate spread that Del

Netherlands was to earn was eliminated in 1992 when the interest

rate of the Royal Bank loan was increased to 1½ percent.

Northern Ind. Pub. Serv. Co. provides no support for Del

Commercial.

   Under section 6651(a)(1), an addition to tax is imposed for

failure to file a tax return, and under section 6656, an addition

to tax is imposed for failure to timely deposit a tax due in a

Government depository, unless it is shown that such failures were

attributable to reasonable cause and not to willful neglect.    Del
                               - 13 -

Commercial has not presented any credible argument that the

failure to file and the failure to timely deposit withholding

taxes due on interest paid on the $14 million loan were

attributable to reasonable cause.   Respondent’s determinations of

the additions to tax are sustained.

   To reflect the foregoing,

                                           Decision will be entered

                                      under Rule 155.
