United States Tax Court

“ The transactions of 1981 were structured as purchases by Erhard of the various assets at fair market values based upon competent appraisals. However, as the record amply demonstrates, the purported purchases were made possible only by the circular money movements orchestrated by Margolis. The artificial nature of the money movements and the absence of any economic substance in the ephemeral contractual relationships created by such money flows deprives the entire series of transactions of any economic validity. In short, the transactions were illusory in nature. ”

“ Petitioner contends that the decision to shed est, a.e.c. in 1981 and continue the Erhard operations as Werner Erhard & Associates, a sole proprietorship, was prompted by business realities and that the transactions between WEA and est, a.e.c., as well as the financial obligations purportedly incurred, were thus valid and should be given effect for tax purposes. The business reality, argues petitioners, was to escape the perceived financial damage to the enterprise caused by the continued association of the enterprise with Margolis. ”

“ An examination of the circular money flow in each of the four phases, in which the participation and orchestration by Harry Margolis is amply demonstrated by the record, underscores the complete absence of economic substance sufficient to support the depreciation and interest expense deduction here at issue. In phases one and two the various amounts simply circled out of the system through WEA and back into the system except for cash retained by WEA from the flow in the amount of $2,249,323 in phase one and $850,854 in phase two. ”

“ If we intend to deal the death blow to these perceptions and problems, we want a legal and financial structure which is simple, easy to explain and honest, one which can be understood by anyone and which is morally right, ethical and consistent with purpose. ”

“ Instead, Island Bank, Ltd., made funds available to overseas system entities which in turn would make the actual loans. The process by which Island Bank, Ltd., made funds available to an overseas system entity followed a standard procedure in the operation of the Harry Margolis system. Generally, the overseas system entity would agree to make a loan and Island Bank, Ltd., would then provide the necessary financing by making the funds available to the lending entity. ”

“ The Body of Knowledge was created by Werner Erhard, who was also the original developer of the est training. Erhard continued as the primary developer of the training and he decided when a particular trainer was qualified or capable of leading the training. Erhard received W-2 income from est, a.e.c. in the years 1975 through early 1981. Prior to the formation of WEA in 1981, est, a.e.c. had between 300 and 350 employees and owned the requisite business assets for its operations such as leaseholds, leasehold improvements and computer equipment. ”

“ The Barclays Bank of San Francisco loan was secured by Parallax, a system entity. The proceeds of the loans were then used by WEA to acquire the operating assets from est, a.e.c., to repay a Werner Erhard loan from Barclays Kol, to repay a Werner Erhard loan from Associated Advisors, to acquire certain art works from Alexia, to pay a deposit to Associated Advisors for the auxiliary sloop Sirona, and for a quitclaim from PMSA. Many of the monetary transfers to and from WEA to effectuate these transactions took place on June 1, 1981. ”

“ Mator, S.A., was a trust management company providing accounting, administrative, statutory and other related services for corporate entities.
The representation of clients in the office of Harry Margolis generally consisted of (1) an initial phase during which the client's goals were defined and documents were drafted to realize such goals; and (2) an implementation stage during which the required relationships were established; and (3) a so-called clean-up phase when the client desired to terminate the contractual relationships which were then phased out. ”

“ The books and records of ICF are audited on an annual basis by a Swiss accounting firm. In April 1981, Werner Erhard telephoned Somary to explain the formation of WEA and also to inform Somary of the need for a loan of about $9,000,000- $10,000,000. Somary was unable to provide the funds. Shortly thereafter, Somary was called by Margolis who inquired whether Erhard had contacted Somary about the need for financing and whether ICF would be willing to accept funds made available by an entity designated by Margolis and to then lend such funds to the Werner Erhard organization. ”

“ In August 1980, Deull and van Merkensteijn recommended to Werner Erhard and the est, a.e.c. executives that Erhard should conduct the enterprise in the future as a sole proprietorship. In a memorandum to Werner Erhard dated September 16, 1980, Deull and van Merkensteijn explained their recommendation as follows:
The difficulty with the present situation is that it is (1) technically complex, (2) difficult, if not impossible to explain or understand and (3) subject to both public criticism and litigation with the Internal Revenue Service. ”

“ The Harry Margolis system was a group of off-shore and domestic corporations, trusts, banks, partnerships and other entities used by Margolis to implement his tax planning for clients. A system entity refers to an individual entity within the system. System entities were controlled either directly or indirectly by Margolis, his law office or his employees. ”

“ The transactions encountered here illustrate the use of circular money movements and system entities to supplement the Margolis tax-planning. The evidence shows that the money movements were planned in advance in the Margolis office and collated through the use of documentary authorization forms directing the money flow among the participating entities. Moreover, the record clearly shows that the money movement technique made possible a group of transactions with a total value far in excess of the actual cash involved. ”

“ Consequently, we hold that petitioner is not liable for the additions to tax in 1981, 1982, and 1983 under the provisions of section 6653 (a) (1) and (2) .
With respect to returns filed after December 31, 1982, section 6661 (a) imposes an addition to tax on any substantial understatement of income tax. A substantial understatement is one that exceeds the greater of either 10 percent of the tax required to be shown on the return or $5,000. ”

“ Where required, money movements would be made in order to complete the clean-up phase.
The est, a.e.c. organizational structure devised by Margolis in 1975 was a maze of intertwined organizations with numerous agreements among the entities involved. After est, a.e.c. was formed by Margolis in 1975, he created system entities which dealt only with est, a.e.c. These system entities included Welbehagen, B.V., Werner Erhard Charitable Settlement, the Werner Erhard Foundation for est, and WEF est Holding, A.G. Welbehagen, B.V., was an entity in Holland ”

“ In August 1981, Am-Pro notified Alexia of its decision not to acquire the est, a.e.c. stock pursuant to the option agreement.
Wolfgang Somary is a banker in Switzerland. He is a member of the board of the EBC (European Banking Company) Switzerland Ltd., Corp., and is also a partner and director of STA Salmann Trust of Valduz, an asset management company. Upon his father's death, Somary took over his father's private bank, Blankart & Company. Somary merged Blankart & Company into a larger Swiss private bank, Bank Sarasin, where he was a managing director and limited partner until 1985. ”

“ John Fundacion was to receive a conditional grant loan of $14,000,000 from ICF and, in turn, to loan this amount to WEA. Flores did nothing to insure that the $14,000,000 loan would be repaid by Werner Erhard. Flores understood that it was the responsibility of ICF to insure repayment of the note in view of the endorsement by Flores of the note back to ICF. After Somary and Margolis discussed the opening of a bank account for ICF at FNBBP, Somary suggested to Flores that the pending banking transaction involving the money transfer should take place at FNBBP rather than in Costa Rica. ”

“ A client earned interest on positive balances in the system accounting maintained for him and was charged interest on negative balances. Transactions between system entities were not recorded in the system accounting since the funds stayed within the system. The office of Harry Margolis maintained only one combined system accounting for Werner Erhard and est, a.e.c. ”

“ Am-Pro Marketing, Inc., (hereinafter Am-Pro) is a sales and marketing company primarily engaged in marketing a fuel additive product manufactured by Bell Laboratories in Florida. BEC filed a petition in bankruptcy in 1985 or 1986. Johnny Brown was president of both BEC and Am-Pro. ”

“ Respondent disallowed both the depreciation expense deduction and the interest expense deductions on the grounds that (1) the transfer of assets should be disregarded because there was no real change in the ownership of the assets and that the transaction lacked economic substance; (2) the $14,000,000 and $1,000,000 loan transactions were Margolis circular money movements which lacked economic substance; (3) the transaction was purely tax-motivated and lacked any business purpose ”

“ On September 9, 1981, Erhard requested that an account be opened for him designated as d [FNb] a WEA at FNBBP with an initial deposit of $500. On July 12, 1982, this account at FNBBP (indicating a balance of $500) was closed. ”

“ Foundation will deposit fourteen million dollars ($14,000,000) to the account of San Juan at the First National Bank of Boston, Panama City, Panama, on September 15, 1981.
2.) Said sun is intended to constitute a restricted loan and grant by Foundation to San Juan, as herein set forth. 3.) The parties share goals and aspirations in a broad range of human affairs. They intend that the fourteen million dollars ($14,000,000 US) shall be made available to Werner Erhard, doing business as Werner Erhard and Associates, for a period of ten (10) years. ”