## Facts

- Fadhlalla Haeri was an officer and shareholder of Project Development Corporation (PDC), a consulting company serving oil companies operating in the Middle East.
- In February 1981, Haeri, who owned 47% of PDC, transferred his PDC shares to a trust for the benefit of himself and his family.
- PDC owned multiple subsidiary corporations, including Haeri & Associates (H&A), a corporation organized under Panamanian law to provide consulting services to European and American oil companies.
- H&A issued stock, had officers and directors, and maintained a bank account.
- In July 1981, H&A entered into a contract with Ashland Industries (Bermuda) Limited (AIBL) to provide consulting services aimed at increasing AIBL’s oil allotments and obtaining releases from certain other consulting contracts.
- During 1981 and 1982, AIBL paid H&A more than $3,000,000; the payments were deposited into H&A’s bank account and then transferred to PDC’s bank account.
- Haeri did not report the AIBL payments as personal income on his 1981 or 1982 federal income tax returns.
- The Commissioner issued a notice of deficiency treating the AIBL payments as income to Haeri personally, asserting that H&A was a sham corporation and asserting additions to tax for 1981 and 1982.
- Haeri and his spouse petitioned the United States Tax Court for redetermination.

## Issues

1. Whether H&A should be disregarded as a sham corporation for federal income tax purposes so that the consulting payments from AIBL would be taxable to Haeri personally rather than to the corporate group.
2. Whether the Commissioner’s deficiency determinations reallocating the AIBL payments to Haeri personally should be sustained for 1981 and 1982.
3. Whether additions to tax asserted in connection with the reallocation of the AIBL payments should be sustained.

## Decision

- The Tax Court held that H&A was not a sham corporation and would be respected as a separate entity for federal income tax purposes.
- The Tax Court declined to include the AIBL consulting payments in Haeri’s personal income merely because of his role and ownership interests within the PDC corporate structure.
- Because the Commissioner’s principal reallocation theory failed, the deficiencies and related additions to tax premised on taxing the AIBL payments to Haeri personally were not sustained on that theory.

## Legal Principles

- A corporation that is properly formed and operates with real business activity will generally be recognized for federal tax purposes; the IRS may disregard an entity only where it lacks economic reality and functions as a mere shell.
- Corporate formalities and operational facts (such as issuance of stock, existence of officers/directors, and maintenance of a corporate bank account) weigh against treating a corporation as a sham.
- The assignment-of-income doctrine prevents a taxpayer from shifting tax on income the taxpayer personally earns; however, where a bona fide corporation is the contracting party and conducts the business activity, the corporation—not the shareholder—generally recognizes the service income.
- Routing funds within a corporate group, without more, does not by itself establish that the payee corporation is unreal or that the income must be taxed to an individual shareholder.
- Additions to tax tied to an asserted underpayment depend on the existence and amount of an underpayment and on the taxpayer’s conduct; when the substantive reallocation is rejected, penalty determinations based on that reallocation ordinarily fall with it.

## Conclusion

In *Haeri v. Commissioner*, the Tax Court rejected the IRS’s attempt to disregard a Panamanian consulting subsidiary as a sham and to tax more than $3 million of Bermuda client payments to the individual shareholder. Treating H&A as a real operating corporation within the PDC group, the court declined to reallocate the consulting fees to Haeri personally and, as a result, did not sustain the deficiencies and related additions to tax that depended on that sham-entity theory.


Haeri v. Commissioner, T.C. Memo 1989-20 (1989)