                       108 T.C. No. 27



                UNITED STATES TAX COURT


TAIYO HAWAII COMPANY, LTD., Petitioner v. COMMISSIONER
            OF INTERNAL REVENUE, Respondent



Docket No. 10159-95.                 Filed June 25, 1997.



     P, a foreign corporation wholly owned by a foreign
conglomerate, was engaged in real estate activity in
Hawaii. P borrowed funds from foreign banks and also
received advances from its parent and a related foreign
corporation. Interest on bank borrowing was paid, and
interest on advances from related corporations was
accrued and not paid. P reported the interest as
deductible. After an audit examination, respondent
determined that the accrued but unpaid interest was
subject to the excess interest tax provided for in sec.
884, I.R.C. P, although reporting the advances from
related corporations as debt, now claims that they
were, in substance, equity. P also contends that the
accrued and unpaid interest is not deductible due to
sec. 267, I.R.C., and therefore sec. 884 should not
apply. Finally, if it is concluded that sec. 884
applies, P argues that certain of its property did not
qualify as part of the base for computing the excess
interest tax.
                               - 2 -


          Held: The advances were debt, and P is subject to
     the sec. 884 excess interest tax provisions. Held,
     further, sec. 884 and regulations interpreted--excess
     interest tax provisions apply. Held, further, the
     questioned assets are includable in the excess interest
     tax computation.


     Michael Rosenthal and Thomas E. Busch, for petitioner.

     Jonathan J. Ono, for respondent.



     GERBER, Judge:   For the taxable years ended September 30,

1989, 1990, and 1991,1 respondent determined deficiencies in

petitioner's Federal income taxes in the amounts of $35,529,

$71,692, and $84,331, respectively.    Respondent also determined

an $8,433 addition to tax under section 6651(a)(1)2 for 1991.

     The issues for our consideration are:   (1) Whether

petitioner is liable for excess interest tax under section

884(f)(1)(B) for 1989, 1990, and 1991; (2) if petitioner is

liable for the excess interest tax, whether certain assets should

be included in the taxable base; and (3) whether petitioner is

liable under section 6651(a)(1) for failure to timely file a

return for 1991.


     1
        All taxable years shown in this opinion, although
expressed simply as years, refer to taxable years ended Sept. 30
of the referenced year.
     2
        Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the period under
consideration. Rule references are to this Court's Rules of
Practice and Procedure.
                                - 3 -


                          FINDINGS OF FACT3

     At the time its petition was filed, petitioner, Taiyo Hawaii

Co., Ltd. (Taiyo Hawaii), had its principal place of business in

Honolulu, Hawaii.    Petitioner was a Japanese corporation engaged

in real estate activity in Hawaii.      Petitioner was incorporated

on October 30, 1985, with its outstanding capital stock held by

Taiyo Fudosan Kogyo Co. (Fudosan), a Japanese corporation.

Pursuant to an October 31, 1985, merger agreement, Fudosan

transferred its Hawaiian assets to petitioner and its Japanese

assets to another related company.

     Fudosan and another Japanese corporation were merged into

the Seiyo Corp. (Seiyo), a Japanese corporation, as of January 1,

1986.    As part of the merger, Seiyo acquired (and retained

throughout the years in issue) petitioner's issued and

outstanding capital stock.    Seiyo was part of the real estate and

tourism group of a Japanese conglomerate, Seibu Saison Group.

     On October 1, 1988, petitioner's assets included:     Cash;

certain receivables; a condominium in Waikiki, Hawaii; a 50-

percent interest in a Hawaiian partnership, T-3 Wailea Joint

Venture; and certain unimproved real property on the island of

Hawaii.    The Hawaiian realty had been held by petitioner since

1986, having been acquired by Fudosan between 1973 and 1980.       One


     3
        The parties’ stipulation of facts and the attached
exhibits are incorporated by this reference.
                                 - 4 -


portion of the realty was known as the "Ginter Property" and the

other as the "Gomes Property".

     Petitioner initially continued Fudosan's lead and sought to

develop the realty.    An architect was retained to prepare

development plans that were submitted to the local county

planning commission responsible for land development.       Petitioner

proposed that the Ginter property, which was zoned for single-

family residences, be subdivided into 7,500- and 15,000-square-

foot residential lots with houses.       Subsequently, petitioner

commissioned a feasibility study concerning development of a 9-

or 18-hole golf course in proximity with the Ginter subdivision.

Petitioner sought to develop the Gomes property into

approximately 300 subdivided residential units and a botanical

garden.

     Prior to the taxable years before the Court, petitioner

encountered significant impediments that ultimately proved fatal

to its development plans.    On several occasions, the County of

Hawaii proposed the construction of a major highway through the

Ginter property, which would have provided the necessary access

for development.   The proposed highway was never constructed.

Also, the Gomes property was located in a flood plain, and

substantial drainage work would have been required prior to

further development.    Petitioner determined that the cost

(several millions of dollars) to improve the Ginter and Gomes
                                 - 5 -


properties was too large to warrant development.    Petitioner did

not receive any revenue from either the Gomes or Ginter

properties during the years at issue.    Petitioner did not

advertise the properties for sale, and no bona fide purchase

offers were received until 1995.

     On May 2, 1995, an unrelated company, Towne Development of

Hawaii, Inc., made an offer to purchase and did eventually

purchase the Ginter and Gomes properties.    The purchase price was

to be approximately $3 million.    A possible cloud on the title,

however, caused the price to be reduced to $2.4 million.

     With respect to the joint venture, T-3 Wailea partnership,

petitioner owned a 50-percent interest and was also the managing

partner.   The joint venture owned approximately 600 acres of land

immediately above Wailea, Hawaii.    In 1990, petitioner liquidated

its interest in the T-3 Wailea partnership in exchange for a

$5,963,431 distribution, resulting in a $2,450,722 profit.

     Sometime in 1990, petitioner acquired a 50-percent interest

in Pines Plaza Associates, a Hawaiian general partnership engaged

in real property construction.    Petitioner utilized certain

portions of advances from Seiyo and Taiyo Development Co. (Taiyo

Development) to develop the Pines Plaza project.

     Petitioner obtained financing from unrelated financial

institutions including Mitsubishi Trust & Banking (Mitsubishi

Trust), Bank of Tokyo, and Dai-Ichi Bank in order to conduct its
                                - 6 -


real property business activity in Hawaii.     Petitioner also

received advances from its parent corporation, Seiyo, as well as

another related company, Taiyo Development, a Japanese

corporation.   The advances received from Seiyo and Taiyo

Development were reflected on petitioner's books, records, and

tax returns as payables to affiliates.     These advances were

utilized for working capital to develop projects, to pay

outstanding debts owed to financial institutions, and to exploit,

maintain, and hold the Ginter and Gomes properties.

     During the taxable year 1988, Taiyo Development made

advances to petitioner which were not evidenced by promissory

notes or other written instruments.     Although the records in

which the 1988 advances were shown did not expressly reflect a

stated rate of interest, Seiyo had instructed petitioner to

accrue interest at a certain rate on its books.

     At the end of the 1988, 1989, 1990, and 1991 fiscal years,

petitioner had outstanding bank loans with third-party banks, in

the aggregate amounts of $12,722,465, $15,440,132, $13,479,595,

and $5,548,809, respectively.   During the period under

consideration, petitioner paid down several of the loans due to

third-party banks.   The loans were evidenced by promissory notes

executed by petitioner.

     During the taxable years 1989, 1990, and 1991, Seiyo and

Taiyo Development advanced the following amounts to petitioner:
                                   - 7 -


Year                   Seiyo                   Taiyo Development

1989                $5,000,000                    $3,604,746
1990                   191,755                        ---
1991                 2,194,378                        ---

The advances were not evidenced by promissory notes, had no fixed

maturity date, and were unsecured.         The advances were not repaid

during the years in issue.       During the years 1993 and 1994,

petitioner repaid approximately $5 million and $400,000 of the

related party debt, respectively.       There was no stated rate of

interest, and no interest was paid by petitioner on the advances.

Seiyo and Taiyo Development did not demand payment or take legal

action against petitioner regarding the advances.

       At the end of the 1990 and 1991 fiscal years, petitioner's

outstanding liabilities (including advances from Seiyo and Taiyo

Development, bank indebtedness, and miscellaneous liabilities)

and the tax basis of its assets were as follows:

         Fiscal
       Year Ended   Outstanding Total            Tax Basis
        Sept. 30       Liabilities               of Assets

         1990         $27,680,245               $20,858,967
         1991          21,955,602                16,907,976

As of September 30, 1995, the outstanding advances (including

principal and accrued interest) totaled $23,875,036.82.

       On its Federal income tax returns, petitioner generally

reported that it was engaged in real estate development and

property investment and real estate investment and development.

On its 1989, 1990, and 1991 tax returns, petitioner reported
                                 - 8 -


"Land Development Costs" of $13,800,857, $13,830,400, and

$11,481,780, respectively.

     Petitioner, on originally filed returns, claimed the

following amounts of interest as deductions related to its

effectively connected income (ECI) from the conduct of a trade or

business in the United States:

          Fiscal Year
             Ended                 Interest Deducted

            9/30/89                       $887,324
            9/30/90                      1,837,751
            9/30/91                      1,346,795

     On its original income tax returns for the taxable years

1989 through 1991, petitioner reported that it had no excess

interest tax liability by means of the following reported

information:

     Fiscal Year
        Ended         Excess Interest Computed

       9/30/89        Designated as N/A
       9/30/90        $1,837,751 - $1,837,751    = None
       9/30/91        $1,346,795 - $1,346,795    = None

     Petitioner, for the years 1989 through 1991, withheld and

paid tax to respondent in an amount equivalent to 10 percent of

the interest paid to third-party foreign banks (Mitsubishi Trust

and Bank of Tokyo), in accordance with the applicable 10-percent

withholding rate under the United States-Japan Income Tax Treaty

(the treaty) as follows:
                                  - 9 -


     Fiscal Year
        Ended
      Sept. 30            Interest Paid           Tax Withheld

         1989              $838,037.66             $83,803.77
         1990             1,451,660.54             145,166.06
         1991               941,821.13              94,182.11

     On or about June 14, 1995, petitioner filed amended 1989,

1990, and 1991 Federal income tax returns.       On the amended

returns, petitioner claimed deductions for interest expense

related to its ECI from the conduct of a trade or business in the

United States, as follows:

     Fiscal Year
        Ended
       Sept. 30                     Interest Deducted
        1989                             $834,750
        1990                            1,307,734
        1991                            1,348,414


     On amended returns, petitioner reported the sum of its

assets and liabilities, as follows:

            Fiscal Year
              Ended            Net Liabilities
            Sept. 30             Over Assets1

                1989           ($8,211,833)
                1990            (8,917,909)
                1991            (7,143,782)
     1
      These amounts were derived from Schedule L of petitioner's
amended Federal income tax returns.

Petitioner's amended returns for 1989, 1990, and 1991, reflected

its net income or loss (prior to the deduction for interest

expense) and gain or loss on its ECI, without considering net

operating loss deductions, as follows:
                                  - 10 -


  Fiscal          Net Income or
Year Ended       (Loss) Prior to             Gain or (Loss)
Sept. 30        Interest Deduction1              on ECI

  1989             ($5,088,223)              ($5,922,973)
  1990               1,201,048                  (106,686)
  1991               4,025,081                 2,676,667
     1
      Petitioner, on its first and second amended 1989 returns,
reported the same net loss, prior to the deduction for interest
expense, as had been reported on its original 1989 return.

     In connection with the amended returns, petitioner filed a

statement entitled "Elections under Treasury Regulation Section

1.884-1(i) and 1.884-4(e)" seeking to reduce its liabilities and

interest expenses, as follows:

     Fiscal Year                                     Interest
        Ended        Liability Reduction         Expense Reduction
       9/30/89          $8,585,294                  $355,292
       9/30/90          10,669,677                   716,924
       9/30/91           8,447,873                   843,312

     Precipitated by respondent's audit examination, petitioner's

accountant, Kent K. Tsukamoto (Tsukamoto), a certified public

accountant, requested that the Seiyo office in Japan provide

copies of promissory notes for the 1988 through 1991 advances.

The employees of Seiyo initially did not understand why Tsukamoto

requested copies of promissory notes evidencing the advances as

loans.   Ultimately, Tsukamoto received a Japanese language

document from Seiyo along with an English translation, entitled

"Confirmation/Acknowledgment".       The document was dated June 2,

1993, and signed by the presidents of Seiyo and petitioner.      It
                                  - 11 -


reflects petitioner as the borrower and Seiyo as the lender, as

follows:
  Loan        Loan Amount       Interest
  Date           (Yen)            Rate                 Conditions

7/31/86       50,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
8/30/86       52,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
11/29/86      20,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
12/31/86      13,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
3/31/87       32,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
6/30/87       30,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
9/30/87       29,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
12/31/87      27,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
3/31/88      158,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
6/30/88       28,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
9/30/88       27,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
12/31/88      27,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
3/31/89       28,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
5/31/89      400,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
6/30/89       31,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority
9/29/89       21,000,000     Short-term prime    Payment of principal   is
                              rate of payment     the priority


Tsukamoto was not aware of some of the advances listed in the

aforementioned document.      No copies of individual promissory

notes evidencing the advances were received.

         On September 30, 1995, petitioner's balance sheet reflected

an outstanding loan of $18,018,708.85, as well as accrued

interest of $5,856,327.97, shown as payable to Seiyo.         Patrick

Kubota (Kubota), petitioner's treasurer and project manager from

1986 through 1994, was responsible for petitioner's accounting
                               - 12 -


and financial records.   Kubota was one of four individuals who

operated and managed petitioner.   He worked with Michio Ito, a

representative of Seiyo who supervised petitioner's Hawaiian

operation.   Seiyo, through Ito, instructed Kubota with regard to

the advances, to accrue certain interest amounts on petitioner's

books and records.

     Kubota had difficulty differentiating petitioner's real

estate development from its real estate investment activity.

Overall, Kubota believed that petitioner would not have had

sufficient funds to pay its bank debt and develop its properties,

as well as maintain and hold the Ginter and Gomes properties, if

it had not obtained the advances from Seiyo.   Kubota also

believed that petitioner was willing, at any point, to sell the

Ginter and Gomes properties provided that a bona fide offer was

received.    Kubota thought that the advances from Seiyo and Taiyo

Development to petitioner were not considered a priority item for

repayment.

     Petitioner's accountant, Tsukamoto, included the advances

from Seiyo and Taiyo Development as liabilities on Schedule L of

petitioner's Federal income tax returns.   In Tsukamoto's

professional judgment petitioner did not have the financial

ability to pay interest and amortize principal on the advances.

The advances to petitioner from Seiyo and Taiyo Development

enabled it to make payments on principal and interest to third-
                                - 13 -


party banks.     Without the advances, petitioner would not have

been able to conduct its real estate development activities as

well as maintaining and holding the Ginter and Gomes properties

from 1988 through 1991.

     Petitioner did not elect under section 882(d) to treat any

of its income from real estate activity as effectively connected

with a U.S. trade or business.

                                OPINION

     The primary controversy concerns whether petitioner is

liable for the excess interest tax pursuant to section

884(f)(1)(B).4    Section 884, here considered by this Court for

the first time, was enacted to create parity between foreign

corporations that choose to operate in branch form and those that

choose to operate through a domestic subsidiary in the United

States.5   See H. Conf. Rept. 99-841 (Vol. II), at II-646 to II-

647 (1986), 1986-3 C.B. (Vol. 4) 1, 647-648; Staff of Joint Comm.


     4
        This subsection is part of the statutory provisions
referred to as the branch tax regime.
     5
        Although included in subsec. (f) of sec. 884, the branch
tax regime is a self-contained group of provisions intended to
achieve parity between branch operations and domestic
subsidiaries of foreign corporations. The application of these
provisions is complicated due to their complexity, lack of
specific definitions, and reliance on Internal Revenue Code
concepts that do not necessarily comport with the sec. 884
structure. Artificial bases are used to reach parity, and
certain distinctions made in other portions of income taxation
are ignored for purposes of the branch tax laws. These
attributes have made our analysis more difficult.
                              - 14 -


on Taxation, General Explanation of the Tax Reform Act of 1986,

at 1037 (J. Comm. Print 1987).    To achieve that result, three

distinct taxes may be imposed.6   Section 884(a) imposes a tax on

earnings of a U.S. trade or business deemed to be repatriated by

a foreign corporation.   Section 884(f)(1)(A) treats certain

interest paid by the U.S. trade or business of a foreign

corporation (referred to as branch interest) as if it were paid

by a domestic corporation.   This is accomplished by subjecting

the interest to withholding under sections 881(a) and 1442, as if

it were U.S.-source income paid to a foreign person or entity.

Finally, section 884(f)(1)(B) imposes a tax on excess interest to

the extent the interest deduction allocable to the U.S. trade or

business in computing its taxable ECI (as provided for in section

1.882-5, Income Tax Regs.) exceeds the branch interest of section

884(f)(1)(A).   The excess interest is treated as if it were paid

to the foreign corporation by a wholly owned domestic corporation

     6
        The three taxes to achieve parity are in addition to any
tax under sec. 882(a) on income of a foreign corporation engaged
in a trade or business within the United States that is
effectively connected with the conduct of the trade or business
in the United States.
     "Effectively connected income" (ECI) is a term of art
defined in sec. 864(c). ECI includes certain types of foreign
source income earned by a foreign corporation. Sec. 882 allows
certain deductions and credits for ECI, and the net income is
subject to tax.
     Conversely, income that is not effectively connected with
the conduct of a trade or business in the United States is
subject to U.S. taxation at a flat rate of 30 percent unless a
different amount is provided for in an income tax treaty. Sec.
881.
                              - 15 -


on the last day of the foreign corporation's taxable year and

subject to tax under section 881(a) (the excess interest tax).

The controversy here concerns the excess interest provisions.

     The excess interest tax ties in with the withholding

provisions of section 884(f)(1)(A).    The withholding on interest

paid to foreign persons or entities is a means of collecting tax

on the interest recipient, whereas the excess interest tax of

section 884(f)(1)(B) is imposed on the foreign branch payor.     The

interest deduction allocable to the branch is determined by a

formula provided in section 1.882-5, Income Tax Regs., and is an

apportionable amount of ECI, which is used as the base.   The

amount of interest deductible for purposes of the branch tax law

is therefore derived in a theoretical fashion7 to complete the

statutory configuration designed to achieve parity between a

foreign branch and a domestic subsidiary of a foreign parent.

     Here, petitioner, a Japanese corporation wholly owned by

another Japanese corporation, obtained funding from unrelated

banks and also from related corporations (its parent and another

related corporation).   Petitioner paid interest on the loans from

unrelated banks.   Also, petitioner accrued interest without

making any payments on the funds obtained from the affiliated


     7
        The amount derived is not necessarily equivalent to the
amount of interest actually paid or accrued. Instead, the
deductible amount of interest pursuant to sec. 1.882-5, Income
Tax Regs., is an amount prescribed to achieve parity.
                               - 16 -


companies.   On its Forms 1120F, U.S. Income Tax Return of a

Foreign Corporation, petitioner reported interest paid by a U.S.

trade or business (branch interest) under section 884(f)(1)(A) to

include the accrued amounts in connection with the funding from

related foreign sources.    Petitioner did not withhold any amount

under sections 884(f)(1)(A) and 1442 with respect to the accrued

interest but did withhold with respect to the interest paid to

the unrelated banks.    Respondent, following the audit examination

of petitioner, determined that the accrued interest to related

entities did not qualify as branch interest and, instead,

constituted excess interest within the meaning of section

884(f)(1)(B).

     After respondent determined that there was an excess

interest tax liability, petitioner attempted to fashion a

solution for relief that would also avoid any additional tax to

petitioner or its parent.    The branch tax law contains various

provisions designed to permit alternatives to the tax under

section 884 and to enable a taxpayer to choose which provision of

that section applies.   The "relief" provisions include elections

that, for example, would permit shifting the tax burden from

section 884 to section 882(e) as ECI or from excess interest tax

to branch interest withholding (section 884(f)(1)(B) to (A)).

None of the approaches provide the tax relief that petitioner

seeks.   Petitioner has also proposed several alternative
                               - 17 -


approaches under which it is seeking both to avoid the excess

interest tax under section 884(f)(1)(B) and, in the process, to

avoid bearing the tax burden of another provision of the branch

profit tax regime.

     In that connection, petitioner did not make an election

under section 1.884-4T(b)(7), Temporary Income Tax Regs.

(finalized in 1992 as sec. 1.884-4(c)(1), Income Tax Regs.), 53

Fed. Reg. 34054 (Sept. 2, 1988), to treat the accrued interest as

paid in the year of accrual, thereby relieving itself of the

potential for excess interest tax liability.8   The election by a

foreign corporation must be made with its income tax return, its

amended income tax return, or a separate written notice to the

Commissioner of Internal Revenue, none of which was done in this

case.    See sec. 1.884-4T(b)(7)(iii), Temporary Income Tax Regs.,

supra (finalized as sec. 1.884-4(c)(1)(iii), Income Tax Regs.).

     After respondent's audit began, petitioner filed amended

Forms 1120F for the years under consideration seeking to

eliminate any excess interest by attempting an election to reduce

the affected liabilities under section 1.884-1(e)(3), Income Tax

Regs.    Finally, after filing the petition in this case,

     8
        If petitioner had made that election, it would have been
binding for all years, and petitioner would then have been
subject to a 10-percent withholding obligation under art. 13 of
the U.S.-Japan Income Tax Treaty (the treaty). Convention for
the Avoidance of Double Taxation, Mar. 8, 1971, U.S.-Japan, art.
13, 23 U.S.T. (Part I) 967, 990. Under the treaty, the
withholding under sec. 1442 is reduced from 30 to 10 percent.
                               - 18 -


petitioner posed two additional alternative arguments in support

of its allegation that respondent's excess interest tax

determination is in error.    Petitioner contends that the advances

from related entities were equity rather than debt and, as a

second alternative, that section 267(a)(3) prevents the

application of the excess interest tax because the deduction for

its interest obligations to the related entities is prohibited.

If we do not accept petitioner's primary arguments, petitioner

also argues that:    (1) Generally, the excess interest tax

violates the nondiscrimination clause of the treaty, and/or (2)

certain properties held by petitioner were not U.S. trade or

business assets for purposes of calculating the excess interest

tax.

       Debt vs. Equity--We first address petitioner's contention

that the advances in question were equity rather than debt.

Petitioner, taking the position ordinarily advanced by

respondent, argues that there is no deductible interest based on

statutory (section 385) and case law concerning the debt versus

equity issue.    If the advances are not debt for Federal income

tax purposes, as petitioner contends, there could be no

deductible interest expense on the advances and no liability for

the excess interest tax imposed by section 884(f)(1)(B).

Conversely, respondent argues that the debt versus equity issue

should be decided in favor of debt, rather than equity.
                                - 19 -


Respondent, however, raises the threshold question of whether

petitioner should be allowed to disavow the form of the

transaction, which was cast as debt.     In this regard, respondent

agrees that if we find the advances were equity (and not debt),

the matter would be resolved in petitioner's favor.     Petitioner

bears the burden of proof.     Rule 142(a); Welch v. Helvering, 290

U.S. 111 (1933).     If we find that the transaction was cast as

debt, then it would be more difficult for petitioner to disavow

the form and successfully show that the advances were equity in

substance.

         Respondent contends that, prior to the audit, petitioner

treated the advances for financial purposes and tax reporting as

loans or debt.     Petitioner counters that, irrespective of the

labels originally attached to the advances, they were, in

substance, capital contributions.     Petitioner argues that it is

entitled to disavow the form of its transaction.9

     Taxpayers are free to structure their transactions in a

manner that will result in their owing the least amount of tax

possible.     However, the Supreme Court observed in Commissioner v.



     9
        In support of its argument, petitioner, cites J.A. Tobin
Constr. Co. v. Commissioner, 85 T.C. 1005 (1985); Georgia-Pac.
Corp. v. Commissioner, 63 T.C. 790 (1975); J.A. Maurer, Inc. v.
Commissioner, 30 T.C. 1273 (1958); LDS, Inc. v. Commissioner,
T.C. Memo. 1986-293; Inductotherm Indus., Inc. v. Commissioner,
T.C. Memo. 1984-281, affd. without published opinion 770 F.2d
1071 (3d Cir. 1985).
                               - 20 -


National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149

(1974):

     that, while a taxpayer is free to organize his affairs
     as he chooses, nevertheless, once having done so he
     must accept the tax consequences of his choice, whether
     contemplated or not, * * * and may not enjoy the
     benefit of some other route he might have chosen to
     follow but did not. [Citations omitted.]

See also Television Indus., Inc. v. Commissioner, 284 F.2d 322,

325 (2d Cir. 1960), affg. 32 T.C. 1297 (1959).

     Taxpayers have, however, been permitted to assert substance

over form in situations where their “tax reporting and other

actions have shown an honest and consistent respect for * * * the

substance of * * * [a transaction]".    FNMA v. Commissioner, 90

T.C. 405, 426 (1988) (citing Illinois Power Co. v. Commissioner,

87 T.C. 1417, 1430 (1986)), affd. 896 F.2d 580 (D.C. Cir. 1990).

     Petitioner has, for all purposes, treated the advances as

loans and was instructed by its parent corporation to accrue

interest.   Under those circumstances, we reject petitioner's

approach of testing its own choice of form with traditional debt

versus equity considerations, such as the absence of a fixed

payment schedule, maturity dates, enforcement, or formal debt

instruments.10   We are likewise unpersuaded by petitioner's

     10
        Petitioner, for example, relies on the following line of
cases. Hardman v. United States, 827 F.2d 1409 (9th Cir. 1987);
Fin Hay Realty Co. v. United States, 398 F.2d 694 (3d Cir. 1968);
Dixie Dairies Corp. v. Commissioner, 74 T.C. 476 (1980); Nestle
Holdings, Inc. v. Commissioner, T.C. Memo. 1995-441; Green Leaf
                                                   (continued...)
                              - 21 -


accountant's (Tsukamoto's) after-the-fact testimony that, in

retrospect, he should have considered the advances as equity and

reported them as such on petitioner's tax returns.

     Petitioner's approach does not show that the substance of

the advances was not loans.   It merely illustrates that the

parties to the transactions did not follow all of the formalities

that might be considered probative that the advances were debt

rather than equity.   In that regard, petitioner has not shown

that the form of the transaction did not comport with its

substance.   We must take into consideration here the fact that

both petitioner and its parent were corporations formed under the

laws of Japan and that they are foreign entities conducting

business in the United States.   Additionally, when the "home

office" (foreign parent corporation's office) was asked for

evidence of the indebtedness, it provided a foreign language

document, which was translated to reflect the title

"Confirmation/Acknowledgment" and contained a list of advances

and dates made.   With respect to each advance, the document

indicates that "Payment of principal is the priority" and that

the rate of payment is "Short-term prime".   These descriptive

terms are indicative of debt and interest rather than equity or

capital.


     10
      (...continued)
Ventures, Inc. v. Commissioner, T.C. Memo. 1995-155.
                                - 22 -


     Accordingly, we hold that petitioner has not carried its

burden of showing that the substance of the transaction was

different from its form.     Elrod v. Commissioner, 87 T.C. 1046,

1066 (1986); Pritchett v. Commissioner, 63 T.C. 149, 171 (1974)

(citing Ullman v. Commissioner, 264 F.2d 305 (2d Cir. 1959),

affg. 29 T.C. 129 (1957)); Estate of Durkin v. Commissioner, T.C.

Memo. 1992-325, supplemented by 99 T.C. 561, 572 (1992); see also

Estate of Corbett v. Commissioner, T.C. Memo. 1996-255.

     Consistent with our holding, the Court of Appeals for the

Ninth Circuit (the circuit in which this case would be

appealable) has held, in certain instances, that taxpayers may

not cast a transaction in one form, file returns consistent with

that form, and then argue for an alternative tax treatment after

their returns are audited.    See Investors Ins. Agency, Inc. v.

Commissioner, 677 F.2d 1328, 1330 (9th Cir. 1982), affg. 72 T.C.

1027 (1979); McManus v. Commissioner, 583 F.2d 443, 447 (9th Cir.

1978) ("A taxpayer is estopped from later denying the status he

claimed on his tax returns."), affg. 65 T.C. 197 (1975);

Parkside, Inc. v. Commissioner, 571 F.2d 1092 (9th Cir. 1977),

revg. T.C. Memo. 1975-14; In re Steen, 509 F.2d 1398, 1402-1403

n.4 (9th Cir. 1975); Demirjian v. Commissioner, 457 F.2d 1, 5

n.19 (3d Cir. 1972), affg. 54 T.C. 1691 (1970).

     In its tax and financial reporting and other actions,

petitioner has not demonstrated an honest and consistent respect
                               - 23 -


for what it now contends was the substance of the transaction.

Comdisco, Inc. v. United States, 756 F.2d 569, 578 (7th Cir.

1985); Estate of Weinert v. Commissioner, 294 F.2d 750, 755 (5th

Cir. 1961), revg. and remanding 31 T.C. 918 (1959); FNMA v.

Commissioner, supra at 426.

     Having decided that petitioner is bound by the form of the

transaction and that, for purposes of section 884, the advances

in issue were debt as opposed to equity, we now consider

petitioner's alternate arguments.   Because the accrued interest

has not been paid to the related party, petitioner contends that

section 267 prevents its deduction.     Petitioner argues that

interest must be deductible for the excess interest tax to apply.

     Petitioner's Proposed Deductibility Requirement--Section

267(a)(2) generally limits the deductibility of interest by the

payor until it is included in the related payee's gross income.

Section 267(a)(3) empowers the Secretary to promulgate

regulations to apply the matching provisions of section 267(a)(2)

to include instances where the payee is a foreign person

(entity).   In particular, petitioner relies on section 1.267(a)-

3(b)(1), Income Tax Regs.11   Petitioner argues that section


     11
        Petitioner acknowledges and we note that the regulation
relied upon was published Dec. 31, 1992, in T.D. 8465, 1993-1
C.B. 28, a date subsequent to the years under consideration.
Petitioner, however, points out that the Commissioner had
published the essence of that interpretation in Notice 89-84,
1989-2 C.B. 402, for taxable years beginning after Dec. 31, 1983.
                              - 24 -


884(f)(1)(B) does not authorize the deduction of interest; it

merely provides the extent to which interest is allowable as a

deduction in the section 882 computation of ECI.    Petitioner

theorizes that we must look to section 163 for the deduction, and

in turn, the section 267 limitations would then apply.

     Respondent does not comment about or analyze whether

petitioner's section 267 argument is correct.12    Instead,

respondent argues that petitioner's proposed deductibility

requirement is irrelevant because section 884 applies even if the

interest is not deductible.

      The excess interest tax statutory language, in its present

form, does not support petitioner's position that deductibility

of interest on debt to related creditors is a prerequisite to the

application of the excess interest tax.   Section 884(f)(1), as

enacted in the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1241,

100 Stat. 2085, 2579, and amended by the Small Business Job

Protection Act of 1996 (1996 Act), Pub. L. 104-188, sec.

1704(f)(3), 110 Stat. 1755, 1879, provides:

     SEC. 884(f). Treatment of Interest Allocable to
     Effectively Connected Income.--

     (1) In general.--In the case of a foreign corporation
     engaged in a trade or business in the United States (or

     12
        We do not decide here whether sec. 267 is applicable
under the circumstances found in this case. Due to our ultimate
conclusion, it is unnecessary to decide which, if any, limitation
may have existed with regard to the deductibility of the interest
in question.
                             - 25 -


     having gross income treated as effectively connected
     with the conduct of a trade or business in the United
     States), for purposes of this subtitle--

          (A) any interest paid by such trade or business in
          the United States shall be treated as if it were
          paid by a domestic corporation, and

          (B) to the extent the amount of interest allowable
          as a deduction under section 882 in computing the
          effectively connected taxable income of such
          foreign corporation exceeds the interest described
          in subparagraph (A)to the extent that the
          allocable interest exceeds the interest described
          in subparagraph (A), such foreign corporation
          shall be liable for tax under section 881(a) in
          the same manner as if such excess were interest
          paid to such foreign corporation by a wholly owned
          domestic corporation on the last day of such
          foreign corporation's taxable year.

     To the extent provided by regulations, subparagraph (A)
     shall not apply to interest in excess of the amounts
     reasonably expected to be allocable interest.
     reasonably expected to be deductible under section 882
     in computing the effectively connected taxable income
     of such foreign corporation. [Emphasized language added
     and stricken language removed by the 1996 Act,
     effective retroactively to all tax years beginning
     after Dec. 31, 1986.]

     On the basis of the stricken portions of the above-quoted

statutory language, petitioner argues that the interest had to be

deductible before the excess interest tax could apply.13   The

above-emphasized retroactive amendments effective for the taxable

years in controversy, however, obviate any ambiguity that may

have existed in the language that has been retroactively stricken


     13
        Most unfortuitously for petitioner, the statute in
question was retroactively amended subsequent to the trial of
this matter and during the briefing pattern of the parties.
                             - 26 -


from the 1986 statutory version.   See 1996 Act sec.

1704(f)(3)(A)(iii), 110 Stat. 1879, amending section 884(f)

retroactively for tax year beginning after December 31, 1986.

     The report of the House Ways and Means Committee

accompanying the 1996 Act makes it clear that the retroactive

amendments were intended to address an argument similar to that

made by petitioner in this case.   In explaining the provision,

the report contains the statement that

          The bill provides that the branch level interest
     tax on interest not actually paid by the branch applies
     to any interest which is allocable to income which is
     effectively connected with the conduct of a trade or
     business in the United States. * * * [H. Rept. 104-
     586, at 174 (1996).14]
By way of comparison the House report also states, regarding the

withholding of tax from payments by a U.S. subsidiary to its

foreign parent, that



     14
        The Small Business Job Protection Act of 1996 (1996
Act), Pub. L. 104-188, 110 Stat. 1755, was intended to clarify
rather than change the branch profit tax provision. Even in the
context of sec. 884 as enacted by the Tax Reform Act of 1986 (TRA
'86), Pub. L. 99-514, 100 Stat. 2085, and prior to amendment by
the 1996 Act, we think that petitioner's argument would not be
persuasive. The House conference report in connection with the
TRA '86 clearly undermines petitioner's position by demarcating
between interest allocated to a foreign corporation's U.S. branch
under sec. 1.882-5, Income Tax Regs., and interest "actually
paid" by the branch. See H. Conf. Rept. 99-841 (Vol. II), at II-
646 (1986), 1986-3 C.B. (Vol. 4) 1, 646-649. In addition, the
General Explanation of TRA '86 appears to be consistent with
respondent's interpretation of the applicability of the excess
interest tax. See Staff of Joint Comm. on Taxation, General
Explanation of the Tax Reform Act of 1986, at 1037 (J. Comm.
Print 1987).
                              - 27 -


     In the case of a U.S. subsidiary of a foreign parent
     corporation, the withholding tax applies without regard
     to whether the interest payment is currently deductible
     by the U.S. subsidiary. For example, deductions for
     interest may be delayed or denied under section 163,
     263, 263A, 266, 267, or 469, but it is still subject
     (or not subject) to withholding when paid without
     regard to the operation of those provisions.

     *       *       *       *         *        *       *

          These provisions are effective as if they were
     made by the Tax Reform Act of 1986. [Id. at 173-174.]

     We are persuaded that in enacting and retroactively amending

section 884, Congress did not intend to allow the principles of

section 267 to preempt the parity between U.S. branches and

subsidiaries of foreign corporations that the excess interest tax

was designed and intended to accomplish.

     Accordingly, we hold that interest expense allocable to the

ECI of a branch of a foreign corporation is taken into account

for purposes of section 884(f)(1)(B) even if the interest is

rendered nondeductible by section 267.     We reject petitioner's

contention that the deductibility of the interest is a

prerequisite for inclusion in the calculation of a foreign

corporation's excess interest tax liability under section

884(f)(1)(B), and we find that petitioner is subject to the

excess interest tax provisions.15

     15
        Our conclusion is further reinforced by commentators
who, generally, have supported the proposition that the actual
deductibility is not a prerequisite for the application of the
excess interest tax. See Blessing & Markwardt, 909-2d Tax
                                                   (continued...)
                               - 28 -


     Petitioner's Untimely Treaty Discrimination Argument--

Alternatively, if we find the excess interest provisions

applicable, then petitioner argues that section 884(f)(1)(B)

violates article VII (Nondiscrimination) of the treaty.    The

antidiscrimination argument was raised for the first time in

petitioner's reply brief (the final brief in a seriatim briefing

pattern), following respondent's answering and petitioner's

opening briefs.   Although petitioner fashions its argument as

though it were in response to respondent's arguments made on

brief, we find that this position or argument was, to the Court's

knowledge, not raised by petitioner prior to trial, and it was

not raised during trial or in petitioner's opening brief.    Thus,

respondent was not afforded an opportunity to address

petitioner's position.   Petitioner points out that the

Commissioner, in Notice 89-80, 1989-2 C.B. 394, articulated the

position that the excess interest tax provisions do not violate

nondiscrimination provisions of several income tax treaties,

including the one with Japan, to which the United States is a

party.    We find petitioner's attempt to raise this argument to be

untimely.16

     15
      (...continued)
Management, Branch Profits Tax A-33 (1994).
     16
        Petitioner made the generalized argument that, as a
Japanese corporation, it would be treated "less favorably"
because it is "subject to more burdensome taxes" than a similarly
                                                   (continued...)
                             - 29 -


     Are the Ginter and Gomes Properties To Be Included in the

Computation of the Excess Interest Tax?--Next, petitioner

contends that the related-party debt and resulting interest

connected with the Ginter and Gomes properties should not be

included in the base used to compute the excess interest tax.

Petitioner's argument concerns the computation of the excess

interest tax provided by section 884(f)(1)(B).   Under those

provisions, excess interest is computed by subtracting interest

paid by the U.S. branch (branch interest) from the amount of

interest allocable to ECI under section 1.882-5, Income Tax Regs.

Section 1.882-5, Income Tax Regs., provides a three-step process

for determining the amount of interest allocable to ECI.    The

first step determines which assets are U.S. connected by

ascertaining which assets generate ECI from the conduct of a

trade or business in the United States.   Sec. 1.882-5(b)(1),


     16
      (...continued)
situated domestic corporation. In addition, petitioner contends
that sec. 1.884-1(e)(3), Income Tax Regs., violates the
nondiscrimination clause. Petitioner has not made any specific
arguments showing any particular discrimination. For example,
petitioner has not shown or argued that there was no income
against which "excess interest" could be applied or that the tax
on excess interest exceeds petitioner's potential tax benefit
from ECI. Petitioner, using the discrimination argument as a
stalking horse, contends that by providing a taxpayer with the
ability to reduce its U.S.-connected liabilities under sec.
1.884-1(e)(3), Income Tax Regs., without any limitation, there
would be no conflict with the nondiscrimination clause herein.
In general terms, petitioner's loosely formulated discrimination
argument is contrary to the purposes underlying sec. 884 and
without specificity or support.
                                - 30 -


Income Tax Regs.    In the second step, the amount of U.S.-

connected liabilities is determined based on a "fixed" or

"actual" ratio.    The latter is the ratio of the foreign

corporation's worldwide liabilities to its worldwide assets.

Sec. 1.882-5(b)(2), Income Tax Regs.     In the third step, the

U.S.-connected liabilities are multiplied by an appropriate

interest rate to arrive at the interest expense allocable to

ECI.17    Sec. 1.882-5(b)(3), Income Tax Regs.   The branch interest

is subtracted from the interest so allocable to ECI to determine

the excess interest.    The parties disagree over the application

of the three-step process; in particular, whether the Ginter and

Gomes properties are step 1 assets (assets that produce income

effectively connected with the conduct of a U.S. trade or

business).




     17
        Sec. 1.882-5(b), Income Tax Regs., was amended for
taxable years beginning on or after June 6, 1996. Amended sec.
1.882-5(b)(1), Income Tax Regs., retains the three-step process
for allocation of interest expense to ECI but relies on sec.
1.884-1(d), Income Tax Regs., for the definition of a step 1
"U.S. asset". Sec. 1.884-1(d)(1), Income Tax Regs., provides
that an asset is a U.S. asset if "All income produced by the
asset on the determination date is ECI * * * and * * * All gain
from the disposition of the asset would be ECI if the asset were
disposed of on * * * [the determination date] and the disposition
produced gain." As an example of real property which is not
connected to a U.S. business, the regulation describes a U.S.
condominium apartment owned by the foreign corporation which
would not produce ECI if sold. See sec. 1.884-1(d)(2)(xi),
Example (3), Income Tax Regs.
                              - 31 -


     In connection with the resolution of the "step 1

controversy", we also address the validity and effect of

petitioner's attempted retroactive liability election under

section 1.884-1(e)(3), Income Tax Regs.   Section 1.884-1(e)(3),

Income Tax Regs., provides an election under which a foreign

corporation may reduce its U.S.-connected liabilities.   The

effect of the election is to decrease the amount of interest

expense allocated to ECI and, consequently, decrease the amount

of excess interest.18

     On its original returns, petitioner computed the interest

allocable to ECI based on all assets, including the Ginter and

Gomes properties, as "step 1 assets".   In step 2, petitioner's

U.S.-connected liabilities were reported as equal to its

worldwide liabilities.   Finally, in step 3, petitioner treated

all of its worldwide liabilities, including the advances from its

parent and another related corporation, as shown on the books of

its U.S. trade or business.   On the original returns,


     18
        Sec. 1.884-1(e)(3), Income Tax Regs., containing the
election for reducing the amount of excess interest, was
promulgated in 1992, after the years in issue but before
petitioner filed amended returns for those years. The temporary
regulations under sec. 884 that existed during the years in issue
did not provide for a similar election. Respondent does not
argue that petitioner should not be permitted to retroactively
apply the regulatory election to the years in issue. Treating
this as a concession by respondent for purposes of this case, we
do not make any decision regarding the validity of retroactive
application of the sec. 1.884-4(e), Income Tax Regs., election to
years prior to the year in which the regulation was promulgated.
                              - 32 -


petitioner's interest expense allocable to ECI equaled all of its

interest, including the amounts paid to third-party banks and the

amounts accrued in connection with the advances from related

parties.

     After respondent began the audit and raised the excess

interest tax issue, petitioner, in an attempt to eliminate any

excess interest tax liability, filed amended returns attempting

to elect to reduce its liabilities under section 1.884-1(e)(3),

Income Tax Regs.   In this regard, respondent points out that a

foreign corporation may elect to reduce its U.S. liabilities by

an amount that does not exceed the excess of U.S.-connected

liabilities (determined under section 1.882-5, Income Tax Regs.)

over the liabilities "shown on the books of the U.S. trade or

business" (determined under either sec. 1.882-5(b)(3)(i) or

(ii)).   Respondent concedes that prior to the 1996 amendment,

generally, section 1.882-5, Income Tax Regs., does not define

with particularity the meaning of U.S.-connected liabilities that

are "shown on the books".

     With this background, respondent argues that petitioner's

attempted election has no effect because the liabilities shown on

the books of its U.S. trade or business equaled its U.S.-

connected liabilities.   In other words, respondent contends that

petitioner must have some liabilities that were not shown on the

books of a U.S. trade or business in order to make the election,
                               - 33 -


citing section 1.884-1(e)(3)(ii), Income Tax Regs.    We agree with

respondent that petitioner has not shown the requisite

circumstances for a liability reduction as required by section

1.884-1(e)(3)(ii), Income Tax Regs.

     Now, we consider petitioner's argument that the Ginter and

Gomes properties should not be included in the step 1 asset

category.   If petitioner is correct that the two properties do

not belong in the step 1 category, the amount of petitioner's

liabilities subjected to the excess interest provisions and the

amount of the excess interest tax would be reduced.

     The question we must decide is whether unimproved real

property which is not currently being developed is a step 1

asset.    To be included in "step 1", the asset must produce or be

able to produce ECI with the conduct of a U.S. trade or business.

Sec. 1.882-5(b)(1), Income Tax Regs.    Section 864(c) governs the

determination of whether an asset generates ECI.   If a foreign

corporation is engaged in a U.S. trade or business, income from

U.S. sources is generally placed into one or the other of two

categories pursuant to section 864(c)(2) and (3) to determine

whether the income is effectively connected with a U.S. trade or

business.   Section 864(c)(2) applies to fixed or determinable

annual or periodic income and to gains from the sale of capital

assets.   To determine whether such gain or income is ECI, section

864(c)(2) provides two tests: (1) Whether the income is derived
                               - 34 -


from assets used in or held for use in the conduct of the U.S.

trade or business (asset use test), and (2) whether the

activities of the trade or business were a material factor in the

realization of the income (business activities test).   Sec.

864(c)(2)(A) and (B).   All other U.S.-source income, besides

fixed or determinable annual or periodic income and capital

gains, is treated as effectively connected with the conduct of

the taxpayer's U.S. trade or business (regardless of whether an

actual connection exists).   Sec. 864(c)(3).

     Petitioner contends that the Ginter and Gomes properties are

capital assets that produce passive income rather than ECI from a

U.S. trade or business.   Petitioner's argument assumes that the

sale of the Ginter and Gomes properties would not produce ECI

under either the asset use or business activities test of section

864(c)(2).   Respondent contends that the Ginter and Gomes

properties are step 1 assets as petitioner had reported them on

its original Forms 1120F.    Respondent maintains that the Ginter

and Gomes properties are ordinary income assets and would

nevertheless produce ECI under section 864(c)(3).   Respondent

also contends that even if the Ginter and Gomes properties are

capital assets, their sale would produce ECI under section

864(c)(2).   As discussed below, we find that the Ginter and Gomes

properties are ordinary income assets and produce ECI under

section 864(c)(3).
                               - 35 -


     The branch tax law conceptually encompasses income which

could be characterized either as ordinary or capital in nature,

and both capital and ordinary assets may produce ECI.   Thus, the

Ginter and Gomes properties, even if held as capital assets,

could generate ECI.

     For the Ginter and Gomes properties to generate ECI under

section 864(c)(2) or (3), petitioner must be engaged in a trade

or business within the United States.   Petitioner contends that

with respect to the Ginter and Gomes properties, it was not

engaged in a trade or business in the United States.    Petitioner

relies on Neill v. Commissioner, 46 B.T.A. 197 (1942), where it

was held that, without more, the mere ownership of U.S. real

property, "quiescent" receipt of income therefrom, and customary

acts incidental to ownership is not the carrying on of a U.S.

trade or business.    Conversely, where a taxpayer buys and sells

real property, collects rents, pays operating expenses, taxes,

and mortgage interest, makes alterations and repairs, employs

labor, purchases materials, and makes contracts over a period of

years, there is obvious evidence of a U.S. trade or business.

Pinchot v. Commissioner, 113 F.2d 718 (2d Cir. 1940); see also De

Amodio v. Commissioner, 34 T.C. 894 (1960) (active management of

rental property on a "regular and continuous" basis is a U.S.

trade or business), affd. 229 F.2d 623 (3d Cir. 1962); Herbert v.
                               - 36 -


Commissioner, 30 T.C. 26 (1958); Lewenhaupt v. Commissioner, 20

T.C. 151 (1953), affd. 221 F.2d 227 (9th Cir. 1955).

     In Neill v. Commissioner, supra, the taxpayer did not

participate in the management, operation, or maintenance of the

real property other than collecting the rents which her agent in

the United States sent her.    We find petitioner's reliance on

Neill, as it relates to petitioner's business purpose and

generally to its business activity, to be inapposite.      Petitioner

was engaged in the business of real property development and was

formed for the purpose of acquiring, managing, developing, and

selling real property in Hawaii.

     Petitioner argues that a person engaged in the business of

real property development may also hold real property for passive

purposes.   In that connection, petitioner contends that the

Ginter and Gomes properties were not used in a U.S. trade or

business and do not generate ECI.    See sec. 1.882-5(b)(1), Income

Tax Regs.   We disagree.   Although there was no sale or

disposition of the properties during the years in issue,

petitioner's real estate activities were not those of a passive

investor.

     A taxpayer may hold real property primarily for sale to

customers in the ordinary course of his trade or business and, at

the same time, hold other real property for investment purposes.

Maddux Constr. Co. v. Commissioner, 54 T.C. 1278, 1286 (1970);
                                - 37 -


Eline Realty Co. v. Commissioner, 35 T.C. 1, 5 (1960); Tollis v.

Commissioner, T.C. Memo. 1993-63, affd. without published opinion

46 F.3d 1132 (6th Cir. 1995); Planned Communities, Inc. v.

Commissioner, T.C. Memo. 1980-555.       Additionally, a capital asset

may be used in a trade or business, but here petitioner argues

that the assets were held for passive investment purposes.

Although the primary purpose for which a taxpayer holds property

may change, it is the primary purpose for which the property is

held at the time of sale that usually determines its tax

treatment.   Cottle v. Commissioner, 89 T.C. 467, 487 (1987);

Biedermann v. Commissioner, 68 T.C. 1, 11 (1977).       However, we

may consider events over the course of the ownership to determine

the primary purpose for which the property is held at the time of

sale.   Suburban Realty Co. v. United States, 615 F.2d 171, 183

(5th Cir. 1980).   Whether property is held primarily for sale to

customers in the ordinary course of the taxpayer's trade or

business is a question of fact that is to be determined on a

case-by-case basis.     Gartrell v. United States, 619 F.2d 1150,

1153 (6th Cir. 1980); Guardian Indus. Corp. v. Commissioner, 97

T.C. 308, 316 (1991).

     Petitioner's predecessor, Fudosan, acquired the Ginter and

Gomes properties between 1973 and 1980 with the express intention

of developing and selling them as residential properties.

Fudosan obtained a change in the zoning classification from
                             - 38 -


agricultural or unplanned to single or multifamily residential.

Due to a series of mergers, in 1986, petitioner, as a successor

in interest, became the owner of the properties.   Generally,

petitioner continued with the approach begun by Fudosan and

sought to develop the properties until it was subsequently

ascertained that development costs would be insuperable.

Petitioner maintained the zoning conditions and paid certain fees

with respect to the properties.   Petitioner held these properties

as undeveloped land and derived no revenue from them during the

taxable years in issue.

     On its Federal income tax returns, petitioner described its

activity as real estate development and property investment and

real estate investment and development.   In its 1989, 1990, and

1991 returns, petitioner reported $13,800,857, $13,830,400, and

$11,481,780, respectively, in "Land Development Costs".    The

significant real property items, other than the condominium in

Waikiki, were the Ginter and Gomes properties.   Petitioner

consistently reported on its returns that the costs of carrying

the Ginter and Gomes properties were related to its business as a

developer of land.

     There is no question that the Ginter and Gomes properties

were originally intended for development and that regular

business activity was pursued to that end.   Development plans

were drafted and submitted to the planning commission in Hawaii.
                               - 39 -


An architect was retained to prepare plans for the proposed

subdivisions.    The possibility of developing a golf course in

connection with the proposed Gomes subdivision was studied.     At

some point, however, it appears that petitioner became aware that

it was not financially feasible to continue the development.

     Although petitioner originally intended the Ginter and Gomes

properties to be developed, impediments to development such as

drainage, zoning, and lack of accessibility intermittently

stalled development plans.    These factors impeded development

and, ultimately, made development a financial impossibility from

petitioner's point of view.    No efforts were made to sell the

property during the years in issue.     A bona fide offer and sale

occurred during 1995, 4 years after the last tax year under

consideration.

     Generally, courts view frequent sales that generate

substantial income as tending to show that property was held for

sale rather than investment.    Suburban Realty Co. v. United

States, supra at 181; Biedenharn Realty Co. v. United States, 526

F.2d 409 (5th Cir. 1976).    On the other hand, less frequent sales

resulting in large profits tend to show that property was held

for investment.    Bramblett v. Commissioner, 960 F.2d 526 (5th

Cir. 1992), revg. T.C. Memo. 1990-296.

     We hold that the Ginter and Gomes properties are step 1

assets includable in the computation of the excess interest tax.
                                - 40 -


Petitioner's trade or business consisted of real estate activity

in Hawaii.     It acquired, undertook to develop, and held

properties, including the Ginter and Gomes properties, for sale

to customers in the ordinary course of its real estate

development business.    We cannot make the type of distinction

petitioner makes between the Ginter and Gomes properties and the

other properties held by petitioner.     Petitioner's sales activity

was generally sporadic and occurred in large amounts (in the

millions of dollars).    The sales occurring in the years under

consideration were no different from the Ginter and Gomes sale in

1995.     Although petitioner decided that further development was

not warranted, the Ginter and Gomes properties were held for sale

and were sold to the first bona fide offeror.

Section 6651(a) Addition to Tax

        Respondent also determined that petitioner is liable for an

addition to tax for 1991 under section 6651(a)(1) for its failure

to file a timely return.     Section 6651(a)(1) imposes an addition

to tax of 5 percent of the tax due for each month a return is

delinquent, not to exceed 25 percent.     The addition does not

apply if the failure to timely file is due to reasonable cause

and not due to willful neglect.     Sec. 6651(a)(1).   Petitioner

filed its 1991 return past its due date and has failed to show

that its failure to file a timely return was due to reasonable
                             - 41 -


cause and not due to willful neglect.   We find that petitioner is

liable for the addition to tax under section 6651(a)(1) for 1991.


                                   Decision will be entered

                              for respondent.
