Petitioners presented no evidence as to the value of the embryos in the 1984 and 1986 embryo programs, for which they had agreed to pay between $ 36,000 and $ 39,000 per unit. Respondent's expert, Dr. Allen, concluded that the embryos had little or no value for the following reasons: (1) The embryo assignment sheets provided to petitioners as the only documentation to identify the embryos purchased did not contain pertinent information such as the registration numbers and complete names of the sire and dam, the implant date, the date due to calve, 1992 Tax Ct. Memo LEXIS 762">*796 and whether the embryo was fresh or frozen; (2) some of the embryos appeared to have resulted from crossbreeding Simmental and Salers cattle, a cross that would have had little value; (3) some of the embryos appeared to be Romagnola, a breed that was not well known in the United States in 1984 and would have little value; and (4) the programs required extremely high maintenance and management fees. As a result of the above, Dr. Allen concluded that registration of the progeny would not have been possible because of inadequate information on the embryo assignment sheets. In his report, Dr. Allen summarized his opinion of the value of the embryos as follows: "If these embryo units were sold on the open market they would have no value. In other words, under the conditions and financial obligations of these programs informed buyers would not take them even if they were offered free."

Mr. Daily, respondent's other expert, used a cost method in determining a value for the embryos. He considered as cost the $ 3,374 value he found for each of the donor cows and apportioned this cost over the total number of embryos to be produced by the cow over the 5-year period projected in the promoter's1992 Tax Ct. Memo LEXIS 762">*797 offering memoranda, 24 embryos per cow per year for 5 years, and a conception rate of 50 percent. He then added to that the costs involved in preparing the cows for flushing and in implantation of the embryos in recipient cows. Under this cost method, Mr. Daily determined that each embryo unit (20 embryos) had a cost or value of $ 6,647 per unit. If the donor cows were valued at $ 25,000 each, the value of an embryo unit would be $ 10,251.90. Both values, as determined by Mr. Daily, are substantially less than the amounts paid by petitioners in the 1984 and 1986 programs.

The Court disregards Mr. Daily's cost approach in determining the values of the embryos because his approach to value fails to take into account the demand for the product in the marketplace. It is recognized that, since the supply of a particular property may be greater or less than demand, the reproduction cost of such property may bear no relationship to its fair market value. Tracy v. Commissioner, 53 F.2d 575">53 F.2d 575 (6th Cir. 1931), affg. Huron Bldg. Co. v. Commissioner, 15 B.T.A. 1107">15 B.T.A. 1107 (1929). As a general proposition, replacement cost is not favored1992 Tax Ct. Memo LEXIS 762">*798 for tax purposes in arriving at fair market valuations. Ingram-Richardson, Inc. v. Commissioner, T.C. Memo. 1972-157. While reproduction cost may be a factor in determining fair market value, there must be a showing that there is a demand for the property. Lloyd A. Fry Roofing Co. v. Commissioner, T.C. Memo. 1970-298. Replacement cost is not a valid estimate of fair market value in a declining market. Milbrew, Inc. v. Commissioner, 710 F.2d 1302">710 F.2d 1302 (7th Cir. 1983), affg. T.C. Memo. 1981-610; Fox River Paper Corp. v. United States, 165 F.2d 639">165 F.2d 639 (7th Cir. 1948). Mr. Daily expressed no opinion that the embryos could have been sold for the cost he determined as the value of the embryos, or that there was a market for the embryos at these prices. Dr. Allen noted in his report that, in 1984, there were too few embryos sold to establish a market value, and that the conditions and guarantees among the few known sales were highly variable, none of which were similar or comparable to the 1984 and 1986 embryo programs involved in the cases1992 Tax Ct. Memo LEXIS 762">*799 here. Most sales of embryos involved pregnant recipients carrying embryos with known due dates in which the buyer purchased the recipient cow. Dr. Allen pointed out additional "down side" considerations in embryo breeding, such as abortion, calving difficulty, dead calves, high variability in type and performance even among siblings, inferior calves, and bull calves which usually had much lower values than female siblings. He also pointed out that embryos had little or no value unless a pregnancy rate was guaranteed and the sire and dam were among the very elite cattle of the breed. Mr. Daily stated explicitly in his report that the donor cows he appraised in these cases were not of the elite breeding stock that would command premium prices. The cost for production of the embryos, as determined by Mr. Daily, does not constitute an acceptable value for the embryos in these cases. The Court finds that the embryos had a value of $ 250 per unit in both the 1984 and 1986 programs.

Petitioners argued that the purchase prices, while perhaps higher than fair market value, were paid in full by petitioners and should, therefore, be fully recognized for tax purposes. These payments were1992 Tax Ct. Memo LEXIS 762">*800 made or effected by the credits by Alberta Livestock Transplants for sales of embryos or calves and lease payments made by Rivergold Farms to ALT. This argument presupposes that the embryo and calf sales and the donor cow lease were bona fide transactions. The evidence does not support such a conclusion.

The embryo sales petitioners cite as the source of payment of expenses, interest, and principal before inception of the Rivergold lease appear to have had little, if any, substance. All embryos reported as sold on petitioners' behalf were purchased by Alberta Livestock Transplants, who acted both as petitioners' selling agent and as purchaser. All sales were apparently at prices set unilaterally by ALT. No evidence of any attempt to market the embryos to unrelated third parties is in the record.

The lease transaction with Rivergold is similarly without substance. No evidence was introduced to show why Alberta Livestock Transplants would, apparently without receiving any consideration, relinquish its rights to one-half of the embryos obtained from flushing petitioners' donor cows in order to permit Rivergold to assume that role and retain all embryos for itself. This action1992 Tax Ct. Memo LEXIS 762">*801 makes sense only when viewed in the context of the common ownership of majority interests in Rivergold and Alberta Livestock Transplants by Dr. Dyrholm and Mr. Mitenko, and the fact that the transactions essentially required only bookkeeping entries to effectuate the desired result. The Canadian revenue agent who investigated the transactions between Alberta Livestock Transplants and Rivergold described the series of credits and deductions as "a wash" insofar as the two Canadian companies were concerned for Canadian tax purposes -- virtually all amounts shown as income for one company were deductible as an expense by the other. No funds were exchanged except between the related companies, which essentially was a movement of money from one corporate pocket to another corporate pocket. Further, the lease did not effectuate any real change in the status of the cattle as between petitioners and Alberta Livestock Transplants. ALT, through Rivergold, continued its control over the cattle during the lease term as it had before, simply crediting the notes for their remaining balances through the device of lease payments rather than purchases of petitioners' one-half of the embryos.

Finally, 1992 Tax Ct. Memo LEXIS 762">*802 it is illogical that Rivergold would be willing, in an arm's-length transaction, to pay $ 20,300 per head to lease cows which could have been purchased for less than $ 3,400 per head. The lease, and the credits to petitioners' notes and accrued accounts for maintenance of the cows, were nothing more than a means of showing petitioners' satisfaction of the notes representing the inflated purchase prices of the cattle without petitioners' being required to put forth any additional funds for that purpose.

In the 1984 embryo program, petitioners point to Alberta Livestock Transplants' crediting of proceeds of sales of calves as the source of payment of their notes. However, there is no evidence that attempts were made to market any of the calves to unrelated third parties; all the sales were to Alberta Livestock Transplants, the original source of the embryos, for amounts set unilaterally by ALT. This permitted Alberta Livestock Transplants to merely credit petitioners' accounts receivable for maintenance costs and "pay off" petitioners' notes by means of bookkeeping entries, without requiring that the transactions yield any true proceeds payable to petitioners. Other than receipt1992 Tax Ct. Memo LEXIS 762">*803 of two unencumbered cows worth little more than the cash they had invested in them, petitioners received no true economic benefit from the program. Even petitioner Jost testified that the fact that the embryo calf sales were all to Alberta Livestock Transplants and at prices that matched exactly the accrued expenses and note payments seemed strange to him:

Q: When you saw the matching numbers there, what was your reaction?

A: Well, it was a little disturbing that these animals were going back and forth to ALT in the first place. When they came out the same, my interpretation was that there may have been some collusion between ALT and Great Western in controlling the price they sold these at.

Q: Can you elaborate? What did you think that collusion might be?

A: Well, price fixing. I thought that ALT and Great Western had arranged to simply sell the cows back to them for the balance of the expenses so we would be satisfied and have two cows.

On this record, the Court concludes that the sales of embryos and calves to ALT and the lease with Rivergold were without economic substance.

In addition to the wide discrepancy between the fair market value of the cows and1992 Tax Ct. Memo LEXIS 762">*804 embryos and the price to the investor in the offering memoranda, there are other factors supporting the conclusion that there was no economic substance to petitioners' transactions. In Houchins v. Commissioner, 79 T.C. 570">79 T.C. 570, 79 T.C. 570">591 (1932), and Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1237-1238, this Court identified six factors in determining whether a sale is bona fide. See also Cherin v. Commissioner, 89 T.C. 986">89 T.C. 997; Massengill v. Commissioner, T.C. Memo. 1988-427, affd. 876 F.2d 616">876 F.2d 616 (8th Cir. 1989). These factors are: (1) Whether legal title passes; (2) the manner in which the parties treat the transaction; (3) whether the purchaser acquires any equity in the property; (4) whether the purchaser has any control over the property and, if so, the extent of such control; (5) whether the purchaser bears the risk of loss or damage to the property; and (6) whether the purchaser receives any benefits from the operation or disposition of the property. Under these criteria, petitioners' transactions in the donor cow and embryo1992 Tax Ct. Memo LEXIS 762">*805 programs were spurious.

As to the first factor, petitioners produced registration certificates from the American Simmental Association and the American Brahman Breeders Association to establish legal title to the cows. Although the director of operations for the American Simmental Association testified that registration certificates do not show ownership and are not analogous to title documents, the fact that the cows were registered to petitioners, and that they eventually sold the cows at auction in 1989, with petitioners receiving the proceeds, indicates that this factor falls in favor of petitioners.

The evidence of title in the embryo programs consisted of bills of sale that did not specifically identify the embryos. Lists or assignment sheets of purported embryos were produced at trial; however, the information contained on the lists was vague, at best, and, according to the expert witnesses, could not have been used to identify with certainty either the embryos or the calves that might have resulted from their implantation. Indeed, petitioners were unable to identify any calves that were born from embryos described on the embryo assignment sheets. The evidence is insufficient1992 Tax Ct. Memo LEXIS 762">*806 to conclude that petitioners acquired legal title to the embryos.

As to the second factor, there is considerable evidence that the parties did not treat the transactions as sales in either the donor cow or embryo programs. At the time the investments were made, none of the cows or embryo units had been assigned, and petitioners received no information identifying their property for several months or, in at least one case, more than 1 year after investing in the donor cow program. Petitioners never received documentation sufficient to identify what they purchased in the embryo programs. The seven calves claimed by petitioners to be 1984 embryo progeny could not have resulted from the matings described on the embryo assignment sheets, and petitioners were unable to otherwise identify any calves born from the embryo programs. Possession of the donor cows or embryos was not transferred to petitioners and remained with Alberta Livestock Transplants, or its related corporation, Rivergold, until the cattle were eventually sold at auction in 1989. The facts and circumstances show that neither petitioners nor the sellers acted as though sales to petitioners ever had taken place.

As 1992 Tax Ct. Memo LEXIS 762">*807 is evident from the preceding discussion of the fair market value of the donor cows and embryo units, petitioners never acquired any equity in the property, the third factor noted above. The balances due on the promissory notes always greatly exceeded the values of the property purportedly acquired.

The fourth factor is whether petitioners had any control over the property. The documents petitioners presented show that petitioners had complete control, exercisable through the cattle managers they contracted with to oversee the donor cows and embryo progeny. Petitioners emphasized at trial their selection of cattle managers to care for their cattle -- first William Max Young & Associates, then Leonard Bestgen and his company, Greatwestern Trading Company, and, finally, Morris & Howland, the business consultants who arranged the auction sale of the cattle for $ 700 per head in 1989. However, the reality is that petitioners were content to leave management of the cattle to whomever was suggested to them, and they never investigated the qualifications of any of the managers before agreeing to their employment. Mr. Bestgen was a former William Max Young & Associates employee, and 1992 Tax Ct. Memo LEXIS 762">*808 petitioners merely acquiesced in his succession to William Max Young & Associates as the manager. Mr. Bestgen, in turn, recommended Mr. Morris as his successor. In fact, petitioners had little, if any, control over the property until Mr. Morris assumed responsibility for the cattle and then sold the cattle shortly thereafter. Petitioners generally were only vaguely aware of the various locations where the cattle were maintained during the programs and received minimal information about their condition.

The fifth factor is whether the purchaser bears the risk of loss or damage to the property. Although the documents indicate that petitioners bore the risk of loss, as a practical matter, because petitioners never acquired any equity in the overvalued cows and embryos, the seller bore such risk. While not formally guaranteed, petitioners expected to receive no less than 10 calves from each unit of 20 embryos purchased in the two embryo programs, regardless of the actual success rate for producing viable pregnancies from their unit. Petitioners understood they would have rights to no more than 10 calves per unit even if more than 10 calves were born from their 20 embryos. These1992 Tax Ct. Memo LEXIS 762">*809 factors indicate that petitioners neither bore a significant risk of loss nor had the right to fully profit from the embryo unit production.

The final factor is whether petitioners were likely to receive any benefits out of the production and disposition of their cows or embryo progeny. Since the donor cows and embryos were substantially overvalued, along with the other factors noted, there was little likelihood that petitioners would ever realize any benefits from the programs.

On this record, the Court holds that there was no economic substance to the donor cow and embryo programs based upon the six factors set out in Houchins v. Commissioner, 79 T.C. 570">79 T.C. 570 (1982) and Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221 (1981).

Where a transaction is not conducted at arm's length by two financially self-interested parties, or where a transaction is based on "peculiar circumstances" which influence a purchaser to agree to a price in excess of the property's fair market value, the Court has disregarded indebtedness to the extent it exceeded fair market value of the purchased asset. See, e.g., Bryant v. Commissioner, 790 F.2d 1463">790 F.2d 1463, 790 F.2d 1463">1466 (9th Cir. 1986),1992 Tax Ct. Memo LEXIS 762">*810 affg. Webber v. Commissioner, T.C. Memo. 1983-633; Odend'hal v. Commissioner, 80 T.C. 588">80 T.C. 588, 80 T.C. 588">604 (1983), affd. and remanded 748 F.2d 908">748 F.2d 908 (4th Cir. 1984); Lemmen v. Commissioner, 77 T.C. 1326">77 T.C. 1326, 77 T.C. 1326">1348 (1981); Roe v. Commissioner, T.C. Memo. 1986-510, affd. without published opinion sub nom. Young v. Commissioner, 855 F.2d 855">855 F.2d 855 (8th Cir. 1988), affd. without published opinion sub nom. Sincleair v. Commissioner, 841 F.2d 394">841 F.2d 394 (5th Cir. 1988).

Petitioners argue that the Court should recognize their indebtedness to the sellers under each program on the following grounds: (1) The notes were recourse; (2) petitioners believed they would have to pay the notes with other resources if the sales of embryos, embryo progeny, or the donor cows did not cover the debt; and (3) the notes were in fact paid by credits from the Rivergold lease and sales of embryos and calves to Alberta Livestock Transplants.

It is the substance of such debt and not its form that must be considered. Waddell v. Commissioner, 86 T.C. 848">86 T.C. 848, 86 T.C. 848">902 (1986),1992 Tax Ct. Memo LEXIS 762">*811 affd. per curiam 841 F.2d 264">841 F.2d 264 (9th Cir. 1988). The courts have refused to give effect to notes which, on face, are recourse notes but which are unlikely to be enforced because of the surrounding circumstances. See, e.g., Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 88 T.C. 1086">1122-1124 (1987), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1989); Helba v. Commissioner, 87 T.C. 983">87 T.C. 983, 87 T.C. 983">1009-1011 (1986), affd. without published opinion 860 F.2d 1075">860 F.2d 1075 (3d Cir. 1988).

An indication that a loan is genuine is the care with which a prospective lender scrutinizes a transaction prior to making the loan to ensure it will be repaid. There is no evidence in these cases that the lender in any of the programs requested even the most rudimentary1992 Tax Ct. Memo LEXIS 762">*812 financial information from the investors. The promissory notes in the donor cow and 1984 embryo program were unsecured, and, in all of the programs, the fair market value of the property for which notes were given in payment was significantly less than the principal amount of the notes. Each of these factors weighs against a finding that the notes represented bona fide indebtedness. As previously discussed, the claimed payment of the notes by means of bookkeeping entries reflecting non-arm's-length sales to Alberta Livestock Transplants of embryos or embryo calves and the equally non-arm's-length lease payments made to ALT by Rivergold are not credible. Under these circumstances, the Court concludes that the "indebtedness" represented by the notes in each program was not genuine; the notes did nothing more than create tax benefits by inflating the purchase prices of the property, thereby increasing petitioners' depreciation and investment credits in the case of the donor cows and also increasing the cost of the embryos deducted as current expenses in the embryo programs. Accordingly, petitioners' indebtedness cannot be recognized for Federal tax purposes. See Goldstein v. Commissioner, 364 F.2d 734">364 F.2d 734, 364 F.2d 734">740 (2d Cir. 1966),1992 Tax Ct. Memo LEXIS 762">*813 affg. 44 T.C. 284">44 T.C. 284 (1965).

In summary, the Court holds that none of the transactions at issue, including the sales to petitioners of the donor cows and embryos, the subsequent lease to Rivergold, and the sales of embryos and embryo progeny calves back to Alberta Livestock Transplants had economic substance.

Having held that the transactions lacked economic substance, the Court addresses the question whether petitioners had a business purpose other than tax avoidance in entering the programs. Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d 1360, 909 F.2d 1360">1363 (9th Cir. 1990), affg. T.C. Memo. 1987-628, affg. in part and revg. in part Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229 (1987), affg. Moore v. Commissioner, T.C. Memo. 1987-626, affg. Sturm v. Commissioner, T.C. Memo. 1987-625. The "business purpose" test involves an inquiry into whether the taxpayer had a legitimate profit objective apart from tax considerations. Shriver v. Commissioner, 899 F.2d 724">899 F.2d 724, 899 F.2d 724">725-726 (8th Cir. 1990), affg. T.C. Memo. 1987-627.1992 Tax Ct. Memo LEXIS 762">*814

The mere assertion of a subjective profit objective will not require recognition of a transaction for tax purposes where the transaction lacks economic substance. Cherin v. Commissioner, 89 T.C. 986">89 T.C. 993. Petitioners testified they entered into the programs seeking profits which might arise from successful embryo transplant breeding operations, and they relied entirely upon the cattle managers and Alberta Livestock Transplants to carry on the ventures. Despite this testimony, the Court is not convinced that petitioners actually had the objective of realizing economic gain from their cattle activities. Many of the same factors that demonstrate lack of economic substance are also important in considering whether petitioners had an "actual and honest profit objective" in engaging in the transactions at issue. Rose v. Commissioner, 88 T.C. 386">88 T.C. 411; Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312, 66 T.C. 312">321 (1976). Additionally, in determining whether a taxpayer intended to profit from an activity in which participation is passive, the Court pays particular attention to whether the taxpayer was prudent 1992 Tax Ct. Memo LEXIS 762">*815 in acquiring the property and assigning duties to third parties with respect to the property, and the extent to which the taxpayer supervised the performance of such duties as the enterprise progressed. Flowers v. Commissioner, 80 T.C. 914">80 T.C. 914, 80 T.C. 914">932 (1983). Specifically, the Court takes into account (in addition to the factors previously discussed in this opinion) such factors as: Whether the taxpayer was knowledgeable of the industry, Sutton v. Commissioner, 84 T.C. 210">84 T.C. 210, 84 T.C. 210">224 (1985), affd. per curiam 788 F.2d 695">788 F.2d 695 (11th Cir. 1986), affd. sub nom. Knowlton v. Commissioner, 791 F.2d 1506">791 F.2d 1506 (11th Cir. 1986); whether the taxpayer attempted to obtain valid information about the industry or researched the feasibility of making a profit in a particular industry, Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 81 T.C. 210">234-237 (1983); whether the taxpayer ultimately relied on the promoters of the program, Estate of Baron v. Commissioner, 83 T.C. 542">83 T.C. 542, 83 T.C. 542">555-556 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986); whether the1992 Tax Ct. Memo LEXIS 762">*816 purchase price was negotiated, Elliott v. Commissioner, 84 T.C. 227">84 T.C. 227, 84 T.C. 227">238 (1985), affd. without published opinion 782 F.2d 1027">782 F.2d 1027 (3d Cir. 1986); and whether any appreciable effort was spent monitoring the investment, Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 90 T.C. 908">936 (1988).

The record does not support a finding that petitioners entered into the donor cow and embryo programs with economic profits in mind. Petitioners made no meaningful independent investigation of the cattle industry or of the risks associated with the use of embryo transplant technology in breeding registered cattle. While petitioners, who are medical doctors, demonstrated interest and general knowledge of genetics and were familiar with the mechanics of the procedures used in cattle embryo transplantation, they made no investigations of market values of registered cattle or the feasibility of the projections in the offering memorandum either before or after investing in the donor cow or embryo programs. The "business" aspect of the programs was clearly not an area about which petitioners had any knowledge or experience, and they made 1992 Tax Ct. Memo LEXIS 762">*817 no efforts to educate themselves in the business aspects of their activity. The promoters overestimated the number of embryos which would be produced from the donor cows, as well as the sales prices of embryos and the calves expected from the embryo programs. There is no evidence to substantiate the validity of the projections in the offering memoranda for the various programs. Both Dr. Allen and Mr. Daily observed that an investigation into market values of registered Simmental cows and embryos would have revealed that the donor cow program, as outlined in the offering memorandum, was not likely to be profitable. Similarly, a review of average market prices for Simmental cattle would have revealed that the projected market for calves from the embryo programs was not likely to be as represented in the offering memoranda. Nevertheless, petitioners never questioned or verified the projections. Information on market prices for such cattle in prior years was readily available from a variety of sources, including the American Simmental Association. The projections in the offering memorandum were based, in the opinions of the experts, on best-case scenarios which were very unlikely1992 Tax Ct. Memo LEXIS 762">*818 to happen. Petitioners had the program materials and projections reviewed by accountants and lawyers but never consulted experts in the cattle industry to ascertain whether the economic projections were realistically achievable.

Petitioners entrusted operation of the program entirely to managers about whom they knew little, if anything, other than the information set forth in the offering memoranda. Further, with the exception of Dr. Jost (who did travel to the offices of the manager in Arizona to obtain information on the identification and location of his donor cows and then went to see some of the cattle), petitioners appear to have been content with the little information provided by the cattle managers about the donor cow program. No information concerning the identity of the donor cows assigned to each petitioner was conveyed to petitioners until several months after their entrance into the programs, and certificates of registration reflecting their ownership on the American Simmental Association records were not received in some cases for more than a year. Moreover, the certificates, once received, often did not match the prior identifying information petitioners had been1992 Tax Ct. Memo LEXIS 762">*819 provided. The registration certificates reflect that some petitioners had been assigned calves born in 1984 rather than mature cows capable of reproduction as they expected. Despite these discrepancies, there is no evidence in the record to indicate that petitioners sought or received clarification or correction of these matters.

With respect to the embryo programs, except for a few registration certificates for animals that could not have resulted from the breedings shown on the embryo assignment sheets they had been provided, petitioners received no information identifying calves born of their embryo units. Petitioners were unable to positively identify any progeny that was consistent with the information they received identifying their embryos. Petitioners purchased 20 embryos per unit and believed they received 10 live births from the embryos but did not know if additional calves might have been born from their embryo units. Although the invoices they received showing sales of unidentified embryo calves reflected Alberta Livestock Transplants as the purchaser of all the calves sold, petitioners never questioned the way the sales were arranged, how the prices were determined, 1992 Tax Ct. Memo LEXIS 762">*820 and why the sales proceeds credited to them equaled exactly the service and maintenance charges payable by them.

No amounts in excess of the predetermined maintenance costs and note payments were received by petitioners from any of the programs prior to the final liquidation of the remaining cattle. Although petitioners reported income from sales of embryos and the Rivergold lease in the donor cow program and from sales of calves in the embryo programs, they received none of the proceeds from any of these transactions and appear to have been content to merely receive credits against their obligations and no more. This lack of interest in the economic performance of the programs beyond their abilities to pay for themselves, together with the other factors, confirms that petitioners did not anticipate profits.

Petitioners, however, did expect and realized substantial tax benefits from the programs, including deductions for depreciation, cattle maintenance, and interest expenses, as well as the investment credit for the donor cow program. Petitioners' notes were ostensibly satisfied by credits from the various transactions detailed above, so petitioners were not called upon for 1992 Tax Ct. Memo LEXIS 762">*821 additional funds for that purpose, and the cash investments petitioners made in the programs were fully recovered through tax refunds or offsets of tax liabilities they would have incurred on income from other sources.

On this record, the Court concludes that petitioners engaged in the transactions to obtain tax deductions and credits and thereby reduce the taxes they would otherwise have been required to pay on their substantial income from other sources. See Beck v. Commissioner, 85 T.C. 557">85 T.C. 557, 85 T.C. 557">570-571 (1985); sec. 1.183-2(b)(8), Income Tax Regs.

Since the transactions lacked economic substance and profit motive, the claimed depreciation and expense deductions and investment credits are not allowable. Accordingly, it is not necessary to address the alternative issues raised by respondent other than those involving petitioners' interest deductions and the additions to tax and increased interest.

The deductibility of interest focuses on the character of the underlying indebtedness -- essentially, whether the debt is bona fide. As discussed previously, the Court examines the substance of the debt and is not guided solely by its form. Debt that, in1992 Tax Ct. Memo LEXIS 762">*822 fact or in substance, is unlikely to be paid lacks economic substance. Waddell v. Commissioner, 86 T.C. 848">86 T.C. 848, 86 T.C. 848">902 (1986), affd. per curiam 841 F.2d 264">841 F.2d 264 (9th Cir. 1988); Estate of Baron v. Commissioner, 83 T.C. 542">83 T.C. 542, 83 T.C. 542">555-556 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986). Due to the inflated purchase prices, the notes petitioners executed represented amounts far in excess of the fair market values of the property which they purportedly purchased. Although "recourse" on face, the notes were so commercially unreasonable the Court does not believe they were ever intended to be repaid and, therefore, holds the notes did not represent bona fide indebtedness sufficient to support interest deductions. The payment of the notes through bookkeeping credits generated by the Rivergold lease and sales of embryos and calves to Alberta Livestock Transplants is not determinative, since the Court has found that such transactions were not arm's-length and were sham transactions. On this record, the Court holds that petitioners have not established their entitlement to interest deductions.

1992 Tax Ct. Memo LEXIS 762">*823 Respondent is sustained in the disallowance of the losses, deductions, and credits claimed by petitioners in all these cases. As a result of the conclusion that the transactions lacked economic substance, petitioners are allowed an appropriate adjustment to eliminate any income they reported from these transactions. See supra note 4.

The remaining issues are the additions to tax and increased interest. Respondent determined that petitioners were negligent in claiming their losses and investment credits and, therefore, determined that they were liable for the additions to tax under section 6653(a)(1) and (2). ⁷ Section 6653(a)(1) provides that, if any portion of an underpayment is due to negligence or intentional disregard of rules or regulations, an amount equal to 5 percent of the underpayment is added to the tax. Section 6653(a)(2) provides for an addition to tax equal to 50 percent of the interest on the portion of the underpayment attributable to negligence. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985).1992 Tax Ct. Memo LEXIS 762">*824

Petitioners deducted depreciation and claimed investment credits on the donor cows based upon prices which significantly exceeded fair market values. Similarly, petitioners in the embryo programs claimed deductions on prices far in excess of the fair market value of the property purportedly purchased. Petitioners made no significant attempts to consult with any independent person having the appropriate expertise to evaluate the validity of the factual representations in the offering materials before relying upon them in claiming tax benefits. Some petitioners testified they consulted with their accountants about the tax benefits represented in the offering memoranda. The Courts have absolved taxpayers from additions to tax for negligence where the taxpayer: (1) Consulted a fully qualified, independent accountant; (2) fully disclosed the facts1992 Tax Ct. Memo LEXIS 762">*825 to the accountant; and (3) then relied upon the accountant's advice in good faith. See, e.g., Betson v. Commissioner, 802 F.2d 365">802 F.2d 365, 802 F.2d 365">372 (9th Cir. 1986), affg. in part and revg. in part T.C. Memo. 1984-264; Leonhart v. Commissioner, 414 F.2d 749">414 F.2d 749 (4th Cir. 1969), affg. per curiam T.C. Memo. 1968-98. However, petitioners did not call their accountants as witnesses, and the record does not disclose the extent and substance of the facts petitioners disclosed to their accountants or the essence of the advice given as a result. See Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93, 864 F.2d 93">96 (9th Cir. 1989), affg. Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086 (1987). Moreover, the Court is skeptical that the accountants or tax advisers possessed the necessary knowledge about donor cows and embryos to intelligently correlate such knowledge with the tax aspects of the transactions. In summary, petitioners' conduct does not evidence the due care and prudence required by the statute. Therefore, respondent's determination that petitioners are 1992 Tax Ct. Memo LEXIS 762">*826 liable for the additions to tax under section 6653(a)(1) and (2) is sustained.

Respondent also determined, as to all petitioners, the section 6659 addition to tax for underpayments attributable to a valuation overstatement. ⁸1992 Tax Ct. Memo LEXIS 762">*829 Section 6659 imposes a graduated addition to tax where an underpayment of $ 1,000 or more is attributable to a valuation overstatement. Section 6659(c) provides that there is a "valuation overstatement" if the value of any property, or the adjusted basis of any property, claimed on a return is 150 percent or more of the correct value or correct adjusted basis. When a transaction lacks economic substance, section 6659 will apply because the correct basis is zero and any basis claimed in excess of that is a valuation overstatement. Gilman v. Commissioner, 933 F.2d 143">933 F.2d 143 (2d Cir. 1991), affg. T.C. Memo. 1990-205; Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524, 91 T.C. 524">566-567 (1988); Donahue v. Commissioner, T.C. Memo. 1991-181, affd. without published opinion 959 F.2d 234">959 F.2d 234 (6th Cir. 1992). This Court and others have found section 66591992 Tax Ct. Memo LEXIS 762">*827 applicable when credits and deductions are disallowed in their entirety due to a lack of economic substance, lack of profit objective, or lack of bona fide sale of the property, when valuation is an integral factor in such determinations. 933 F.2d 143">Gilman v. Commissioner, supra at 151; Massengill v. Commissioner, 876 F.2d 616">876 F.2d 616, 876 F.2d 616">619-620 (8th Cir. 1989), affg. T.C. Memo. 1988-427; Harness v. Commissioner, T.C. Memo. 1991-321; Diego Investors -- IV v. Commissioner, T.C. Memo. 1990-102. In situations where there are arguably two grounds to support a deficiency and one supports a section 6659 addition to the tax and the other does not, the taxpayer may still be liable for the addition to tax. Harness v. Commissioner, supra (citing Gainer v. Commissioner, 893 F.2d 225">893 F.2d 225, 893 F.2d 225">228 (9th Cir. 1990), affg. T.C. Memo. 1988-416, and Irom v. Commissioner, 866 F.2d 545">866 F.2d 545, 866 F.2d 545">547 (2d Cir. 1989), vacating and remanding T.C. Memo. 1988-211).1992 Tax Ct. Memo LEXIS 762">*828 The Court has held that the transactions in these consolidated cases lacked economic substance, and the donor cows and embryos were overvalued. The deficiencies, therefore, are attributable to overstatements of value and are subject to the section 6659 addition to tax. 933 F.2d 143">Gilman v. Commissioner, supra; Massengill v. Commissioner, supra; Harness v. Commissioner, supra; Donahue v. Commissioner, supra.Accordingly, respondent is sustained on this issue as to all petitioners. ⁹

1992 Tax Ct. Memo LEXIS 762">*830 Respondent determined that petitioners are liable for the addition to tax under section 6661 for all post-1981 taxable years except the 1985 year for petitioner Boyer. With respect to Dr. Godwin's 1984 tax year and the 1985 and 1986 tax years of petitioner Nix, the section 6661 addition to tax was determined in the notices of deficiency. Therefore, these petitioners, for these years, bear the burden of proof. However, as to all other years, the section 6661 addition to tax was first asserted by respondent in answers or amended answers. Consequently, respondent bears the burden of proof for those years in which this addition to tax was raised in the answer. ¹⁰ Rule 142(a).

1992 Tax Ct. Memo LEXIS 762">*831 Section 6661(a) imposes an addition to tax if there is a substantial understatement of income tax. A "substantial understatement" is defined as an understatement which exceeds the greater of $ 5,000 or 10 percent of the amount of tax required to be shown on the return. Sec. 6661(b)(1). Any portion of the understatement that is also subject to the addition to tax under section 6659 for a valuation understatement is not taken into account in determining the substantial understatement of tax for purposes of section 6661. Sec. 6661(b)(3). In calculating understatements under section 6661(a), items for which there is substantial authority or with respect to which all relevant facts were adequately disclosed in the tax return, or in a statement attached to the tax return, are not to be considered. Sec. 6661(b)(2)(B). However, in the case of a "tax shelter", even full disclosure in the tax return does not reduce this addition to tax. Sec. 6661(b)(2)(C)(i). For this purpose, section 6661(b)(2)(C)(ii) defines a tax shelter as any partnership, entity or other plan or arrangement, the principal purpose of which is the avoidance or evasion of Federal income tax.

Except as noted herein, 1992 Tax Ct. Memo LEXIS 762">*832 the understatements in tax are "substantial" within the definition of section 6661(b)(1). The Court holds that the transactions in these cases lacked economic substance and business purpose; the principal purpose for the transactions was to reduce petitioners' income tax liabilities. Accordingly, the additions to tax under section 6661(a) are sustained except as to understatements that are reduced below the threshold amounts by adjustments to income consistent with the Court's holding or by application of section 6659.

Finally, respondent determined that the increased rate of interest under section 6621(c), formerly section 6621(d), for substantial understatements attributable to tax-motivated transactions applies to petitioners' donor cow and embryo activities. Tax-motivated transactions under section 6621(c) include valuation overstatements as defined by section 6659 and any sham or fraudulent transaction. Sec. 6621(c)(3)(A)(i), (v). This Court has interpreted "any sham or fraudulent transaction" to include transactions that lack economic substance. McCrary v. Commissioner, 92 T.C. 827">92 T.C. 827, 92 T.C. 827">857 (1989). Accordingly, respondent is sustained on this1992 Tax Ct. Memo LEXIS 762">*833 issue as to all petitioners.

To reflect the foregoing,

Decisions will be entered under Rule 155.