Whether a "partner" owns "a capital interest in a partnership" (the phrase utilized in sec. 704(e)) is a factual issue to be determined from the totality of the circumstances. Sec. 1.704-1(e), Income Tax Regs.; Ginsberg v. Commissioner, 502 F.2d 965">502 F.2d 965, 502 F.2d 965">967 (6th Cir. 1974),1984 U.S. Tax Ct. LEXIS 103">*122 affg. a Memorandum Opinion of this Court; Pflugradt v. United States, 310 F.2d 412">310 F.2d 412, 310 F.2d 412">416 (7th Cir. 1962); Ketter v. Commissioner, 70 T.C. 637">70 T.C. 637, 70 T.C. 637">643 (1978), affd. without published opinion 605 F.2d 1209">605 F.2d 1209 (8th Cir. 1979). Family partnerships must be closely scrutinized by the courts, since the family relationship "so readily lends itself to paper arrangements having little or no relationship to reality." Kuney v. Frank, 308 F.2d 719">308 F.2d 719, 308 F.2d 719">720 (9th Cir. 1962). See also Commissioner v. Culbertson, 337 U.S. 733">337 U.S. 733, 337 U.S. 733">746 (1949); S. Rept. 781, 82d Cong., 1st Sess. 38-40 (1951), 1951-2 C.B. 458, 82 T.C. 335">*344 485-486; H. Rept. 586, 82d Cong., 1st Sess. 32-34 (1951), 1951-2 C.B. 357, 380-381; W. McKee, W. Nelson & R. Whitmire, Federal Taxation of Partnerships and Partners, par. 14.01 (1977) (hereinafter McKee). "Mere shams" will not be recognized for Federal tax purposes. Spiesman v. Commissioner, 28 T.C. 567">28 T.C. 567 (1957), affd. 260 F.2d 940">260 F.2d 940 (9th Cir. 1958);1984 U.S. Tax Ct. LEXIS 103">*123 Fiore v. Commissioner, T.C. Memo. 1979-360, affd. without published opinion 636 F.2d 1208">636 F.2d 1208 (3d Cir. 1980).

Two preliminary matters need to be addressed. First, petitioners argue that the formation of the partnership had a business purpose -- to establish an entity from which the Cirelli corporation could lease equipment; by leasing rather than purchasing equipment, so the argument goes, the Cirelli corporation could improve its working capital and thereby increase its bonding capacity. We find the bonding capacity argument meritless. In many of these transactions (for example, the Mustang loader s.n. 10521 and the Melrose 600 Bobcat), the corporation's bonding capacity suffered more from leasing the property, because the corporation paid more in the first year to rent the equipment than it would have cost to purchase (or keep) it. Moreover, even in those instances in which the corporation's bonding capacity may have been improved vis-a-vis purchasing the property directly, the amount of cash saved was insignificant when compared to the corporation's existing bonding capacity (see pp. 336-337 supra) and could not have1984 U.S. Tax Ct. LEXIS 103">*124 been a good-faith reason for the transactions.

We recognize that, in applying section 704(e), the test may no longer be "whether the parties acted in good faith with a business purpose in joining together to conduct the partnership business." (Emphasis added.) See 310 F.2d 412">Pflugradt v. United States, supra at 415. However, we note that the foregoing language contains a dual standard, i.e., "good faith," and "a business purpose." As a result, we think that, while "business purpose" may not have any independent significance under section 704(e), it is a relevant factor to be taken into account in determining whether the parties herein joined together in good faith. See p. 348 infra. This is particularly true where, as is the case herein, the petitioners have placed great emphasis 82 T.C. 335">*345 on the presence of such a purpose. ²¹

1984 U.S. Tax Ct. LEXIS 103">*125 The second preliminary matter concerns petitioners' contention that, since the partnership agreement provided that each partner had the right to sell his or her interest in the partnership, we must find that each partner in fact owned his or her capital interest. Petitioner's position is not valid. In 70 T.C. 637">Ketter v. Commissioner, supra, Ketter, who operated an accounting practice as a sole proprietorship, established trusts for his children and his college alma mater and then transferred to those trusts the work in progress of his accounting proprietorship and the employment contracts covering his employees. Each trust was irrevocable and could not be altered or terminated by the settlor. Furthermore, each provided that upon a beneficiary's death, the trust would terminate and its assets would be paid to the decedent's spouse and descendants. The initial trustee was Ketter's brother-in-law. The trusts then established a partnership to provide accounting services for accountants, transferred the work in progress and the employment contracts to the partnership, and hired Ketter as manager. The partnership never performed services for anyone but Ketter. 1984 U.S. Tax Ct. LEXIS 103">*126 This Court held that, notwithstanding the validity under State law of the transfers to the trusts (see also 310 F.2d 412">Pflugradt v. United States, supra at 417), Ketter's retention of no reversionary interest in the trusts, and the trusts' rights under the partnership agreement to liquidate their interests, the controls retained by Ketter and the manner in which the partnership conducted its business required that the trusts not be recognized under section 704(e) as owners of the partnership interests. See 70 T.C. 637">70 T.C. 648.

The regulations under section 704(e) list a series of factors to be considered in determining whether a partner is, in fact, the real owner of a capital interest in the partnership. The factors to be considered, which are illustrative rather than exhaustive ( 70 T.C. 637">Ketter v. Commissioner, supra), break down into five categories: retained controls, indirect controls, participation in management, income distributions, and conduct of partnership business. See sec. 1.704-1(e)(2), Income Tax Regs.

82 T.C. 335">*346 The critical fact in this case is the absolute control Cirelli exercised over every 1984 U.S. Tax Ct. LEXIS 103">*127 aspect of the partnership and its business. Notwithstanding the provision in the partnership agreement (and Cirelli's testimony) that Barbara was the partnership's managing partner, the facts clearly indicate that Cirelli, rather than any of his children, controlled C Equipment Co. to the point where the Cirelli children cannot be viewed as partners in the company.

Cirelli's testimony that he merely offered advice to his children and that they made the partnership (management) decisions is simply not borne out by the record. The idea to form the partnership was Cirelli's. He was the person who determined that the corporation needed a piece of equipment and that the partnership should acquire it. It appears from the record that, at least in the instance of the yacht, ²² and most likely in several (if not all) of the other transactions, Cirelli actually purchased the property without conferring with C Equipment Co.'s partners. Moreover, even if the children were presented with the details of a particular transaction before it was entered into, they would have had absolutely no reason to disagree with Cirelli's "advice," and the record contains no evidence to indicate that they 1984 U.S. Tax Ct. LEXIS 103">*128 ever exercised any independent judgment. Since every piece of construction equipment purchased by the partnership was continuously rented by the Cirelli corporation ²³ and since the "fair rental values" of the properties were, for the most part, greatly in excess of the partnership's contractual obligations to pay for such properties, the partnership was, in effect, guaranteed a no-risk profit.

1984 U.S. Tax Ct. LEXIS 103">*129 Cirelli's control over the property after it was purchased is also important. The partnership never leased its property between 1972 and 1975 to anyone other than the Cirelli corporation; indeed, Cirelli would never have caused the partnership to acquire property he did not anticipate the corporation would have a continuing use for. Moreover, the 82 T.C. 335">*347 partnership lacked the ability to store or transport its equipment and hence could not take possession of equipment no longer needed by the corporation, store the equipment, or transport it to other possible lessees.

The manner in which the partnership's business was conducted is also indicative of the children's status as nonpartners. Petitioners have presented no evidence that the children participated in any of the transactions between C Equipment Co. and those who sold or financed the property purchased by the partnership. Statements which Cirelli might have made to these persons, most of whom he had previously dealt with in his capacity as president of the Cirelli corporation, to the effect that he was acting as an agent for a partnership composed of his children, would be insufficient, in and of themselves, to establish1984 U.S. Tax Ct. LEXIS 103">*130 that the children in fact owned interests in the partnership; such a simple requirement would, in this case, elevate form over substance. ²⁴ Moreover, the partnership did not, between 1972 and 1975, attempt in any way to acquire customers other than Cirelli and his corporation.

The corporation's distribution practices and recordkeeping procedures are also indicative of Cirelli's absolute control of C Equipment Co. Between 1972 and 1975, the partnership made distributions sufficient to cover only taxes owed by the children (see Fiore v. Commissioner, supra) and schooling expenses plus a $ 2,500 distribution to Barbara. This last distribution is the only one which we think could conceivably indicate that Cirelli lacked total control over partnership distributions, and yet petitioners made no effort to inform the Court1984 U.S. Tax Ct. LEXIS 103">*131 of the facts surrounding the distribution. Moreover, Cirelli's control is indicated by the fact that he, a nonpartner, was the only person who was authorized to, and did, sign partnership checks between 1972 and 1975 (see p. 339 and note 8 supra) and by the fact that the general check ledger was kept by his secretary.

The final factor which persuades us that Cirelli completely controlled the partnership was Cirelli's inability, on the witness stand, to keep his or his corporation's actions separate from the partnership's actions. For example, Cirelli testified, in discussing the partnership's problems with renting out the 82 T.C. 335">*348 condominium after the corporation moved out, that "we had to appear in court and -- well, they, you know, had to appear." (Emphasis added.) Similarly, in a classic Freudian slip, Cirelli testified that "we [the corporation] have leased our own equipment -- I mean leased equipment from C Equipment Company." Such confusion would not have occurred if the children had exercised sufficient control over the partnership to justify treating them as owning their partnership interests.

We are satisfied that, under the guidelines articulated in the regulations1984 U.S. Tax Ct. LEXIS 103">*132 under section 704(e), petitioners have failed to establish that C Equipment Co. was a valid, existing partnership during the years at issue. 70 T.C. 637">Ketter v. Commissioner, supra.We reach the same conclusion if we apply the subjective test of Commissioner v. Culbertson, 337 U.S. 733">337 U.S. at 742, namely, "whether * * * the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise." (Emphasis added.) Compare Poggetto v. United States, 306 F.2d 76">306 F.2d 76, 306 F.2d 76">79-80 (9th Cir. 1962); Mckee, supra at par. 14.02. See also Carriage Square, Inc. v. Commissioner, 69 T.C. 119">69 T.C. 119, 69 T.C. 119">128 (1977). All of the considerations which led us to conclude that petitioners have not satisfied the guidelines of the regulations under section 704(e) are equally applicable in applying this test. Moreover, in the context of the foregoing language from Culbertson, the absence of business purpose has independent significance. See pp. 342-345 supra.

The long and the short of the matter is that petitioners have not carried their burden of 1984 U.S. Tax Ct. LEXIS 103">*133 proof that the Cirelli children joined together in good faith to form C Equipment Co. (the Culbertson test) or ever acquired ownership interests in the partnership (the sec. 704(e) test by analogy). Accordingly, we find that the partnership was a sham, i.e., nothing more than a conduit for the corporation created out of paper concepts and operated by Cirelli on behalf of the corporation in a manner which simply consisted of carrying on the business of the corporation as if such concepts did not exist. See 308 F.2d 719">Kuney v. Frank, supra at 720.

The net result of the foregoing is that the property "owned" by the partnership will for tax purposes be treated as owned by the corporation. As a consequence, the "rentals" paid by the corporation to the partnership for use of its own property cannot qualify under section 162 as ordinary and necessary 82 T.C. 335">*349 business expenses. ²⁵ However, those deductible expenses and related tax benefits (e.g., investment tax credits) claimed by the partnership in connection with property owned, for tax purposes, by the corporation (other than those attributable to the yacht, see pp. 350-351 infra) will be allowed to the1984 U.S. Tax Ct. LEXIS 103">*134 corporation, as respondent has done in the corporation's deficiency notice. Additionally, we note, at this point, that petitioners have presented no evidence to sustain the deduction by the corporation of $ 4,640.37 for auto and truck expenses and travel and entertainment expenses. Accordingly, the disallowance of that deduction is sustained. See also note 2 supra.

1984 U.S. Tax Ct. LEXIS 103">*135 We turn now to the questions in respect of the yacht expenses. In his deficiency notices to the partners of C Equipment Co. respondent disallowed the deduction of $ 10,853 for yacht expenses, including depreciation. In his deficiency notice to the corporation, respondent disallowed $ 6,500 rental expense. In his deficiency notice to the Charles Cirellis, respondent included $ 9,813 of the yacht expenses as constructive dividends from the corporation. ²⁶

As to the deductibility of the expenses by the partnership, and hence the partners, since we have concluded that the partnership was a sham, the yacht expenses are clearly not deductible by it. The issue with respect to the deductibility of those expenses by the corporation resolves itself into two subsidiary1984 U.S. Tax Ct. LEXIS 103">*136 questions: (a) Was the yacht used in a trade or business of the corporation, and (b) have the requirements of 82 T.C. 335">*350 section 274(a) been satisfied, since the yacht was, at best, an entertainment facility (see Ashby v. Commissioner, 50 T.C. 409">50 T.C. 409 (1968))? We conclude that both questions should be answered in the negative.

The yacht was never advertised as being available for charter. It was never "chartered" by anyone other than Cirelli or the corporation. There is no evidence that there was any bona fide objective that the chartering service which was allegedly contemplated would be profitable, and the record indicates that in 1975 the operation of the yacht produced a substantial loss. ²⁷ To be sure, the log of the yacht (kept by Cirelli) contains vague indications that it was used by the corporation to entertain persons purportedly having some business relationship to the corporation, but petitioner made no effort to flesh out such indications with any specifics with respect to those relationships. Moreover, the yacht was moored at Cirelli's home and there is evidence that the yacht was used on occasions not recorded in the log; for aught that1984 U.S. Tax Ct. LEXIS 103">*137 appears, those occasions could have involved personal use by Cirelli or members of his family. In light of the foregoing and based upon our evaluation of the record as a whole, we are satisfied that petitioners have not carried their burden of proof that the yacht was acquired for any purpose other than the personal benefit of Cirelli. Challenge Manufacturing Co. v. Commissioner, 37 T.C. 650">37 T.C. 650 (1962). At most, the use of the yacht by the corporation, if any, was incidental to such personal benefit. See International Artists, Ltd. v. Commissioner, 55 T.C. 94">55 T.C. 94, 55 T.C. 94">104-105 (1970). Consequently, we conclude that the corporation did not use the yacht in its trade or business within the meaning of section 162 and that none of the expenses relating to the yacht are deductible by it. Transport Manufacturing & Equipment Co. v. Commissioner, 434 F.2d 373">434 F.2d 373, 434 F.2d 373">377 (8th Cir. 1970), affg. a Memorandum Opinion of this Court; International Trading Co. v. Commissioner, 275 F.2d 578">275 F.2d 578 (7th Cir. 1960), affg. a Memorandum Opinion of this Court; American Properties, Inc. v. Commissioner, 28 T.C. 1100">28 T.C. 1100 (1957),1984 U.S. Tax Ct. LEXIS 103">*138 affd. per curiam 262 F.2d 150">262 F.2d 150 (9th Cir. 1958); 50 T.C. 409">Ashby v. Commissioner, supra;Carter v. Commissioner, T.C. Memo. 1978-202, affd. 645 F.2d 82 T.C. 335">*351 784 (9th Cir. 1981). ²⁸ Moreover, the requirements of section 274 have clearly not been satisfied.

1984 U.S. Tax Ct. LEXIS 103">*139 We must next determine whether any of the funds transferred from the corporation to the partnership are taxable to Cirelli as constructive dividends. Respondent determined in the deficiency notice that the $ 9,813.24 in yacht expenses, the $ 18,946.92 in cash disbursements by C Equipment Co. to the children, ²⁹ and the $ 4,640.37 in auto and truck expenses and travel and entertainment expenses ³⁰ constituted constructive dividends to Cirelli. For the reasons below, we agree.

1984 U.S. Tax Ct. LEXIS 103">*140 It is clear that a distribution need not be to a shareholder to be taxable as a constructive dividend; the distribution need only be for the shareholder's benefit. Engineering Sales, Inc. v. United States, 510 F.2d 565">510 F.2d 565 (5th Cir. 1975); Hardin v. United States, 461 F.2d 865">461 F.2d 865, 461 F.2d 865">871-873 (5th Cir. 1972); Sparks Nugget, Inc. v. Commissioner, 458 F.2d 631">458 F.2d 631 (9th Cir. 1972), affg. a Memorandum Opinion of this Court. See Jack's Maintenance Contractors, Inc. v. Commissioner, 703 F.2d 154">703 F.2d 154 (5th Cir. 1983), revg. a Memorandum Opinion of this Court.

We have already determined that the yacht served little, if any, business purpose but, rather, was utilized for the Cirelli family's personal enjoyment. Consequently, the yacht expenses determined by respondent to be constructive dividends are taxable to Cirelli. ³¹ See, e.g., United Aniline Co. v. Commissioner, 316 F.2d 701">316 F.2d 701 (1st Cir. 1963), affg. a Memorandum Opinion of this Court; 37 T.C. 650">Challenge Manufacturing Co. v. Commissioner, supra.In this connection, we note that, 1984 U.S. Tax Ct. LEXIS 103">*141 while the proper measure of a constructive dividend, under the 82 T.C. 335">*352 circumstances herein, is the fair market value of the use of corporate property, the petitioners have not carried their burden of proof that such fair market value is less than the $ 9,813 of yacht expenses which respondent determined to be the amount of the constructive dividend attributable to the yacht expenses. ³²1984 U.S. Tax Ct. LEXIS 103">*143 316 F.2d 701">United Aniline Co. v. Commissioner, supra at 703; 37 T.C. 650">Challenge Manufacturing Co. v. Commissioner, supra at 663. Compare International Trading Co. v. Commissioner, T.C. Memo. 1958-104, affd. on other issues 275 F.2d 578">275 F.2d 578 (7th Cir. 1960). In view of our holding that the partnership was a sham, the amounts of cash distributed to the children constitute constructive dividends to Cirelli (see note 29 supra). 510 F.2d 565">Engineering Sales, Inc. v. United States, supra;461 F.2d 865">Hardin v. United States, supra;458 F.2d 631">Sparks Nugget, Inc. v. Commissioner, supra.³³ Finally, since petitioners have presented neither evidence nor1984 U.S. Tax Ct. LEXIS 103">*142 argument that the auto and truck expenses and travel and entertainment expenses determined by respondent to be constructive dividends should not be so categorized, we find these amounts must also be included in Cirelli's income.

Decisions will be entered under Rule 155.