Was the lease a capital lease (conditional purchase in tax terms) or a true operating lease for taxpurposes? As noted above, justify your answer.Did Dr. Simba receive a constructive dividend? Whether a constructive dividend exists turns on whetherthe distribution was primarily for the benefit of Lion Imaging and this Dr. Simba as its sole shareholder orfor Lion Heart, since it derived as least some benefit from the improvements as they actually owned thebuilding.Case Details / Fact PatternDr. Simba is a cardiologist who conducts his medical practice through Lion Heart. In 2003, Lion Heartleased a cardiac CT scanner from Narla Medical Solutions USA, Inc. (Narla), for a 60-month term. Theestimated useful life of a CT scanner is generally assumed to be approximately 5 years. Dr. Simba signedthe lease on behalf of Lion Heart, and the lease was secured by a $500,000 life insurance policy on Dr.Simba naming Narla as the beneficiary. The lease provided that Lion Heart could not assign or dispose ofits rights or obligations under the lease or enter into any sublease without Narla’s written consent. Thelease also included an option to purchase the CT scanner at less than fair market value at the end of thelease thus making the lease a capital lease for financial reporting purposes.In 2004, Lion Heart paid $4,000 to WRB Custom Constructions for construction work to accommodatethe CT scanner. The construction work included erecting new lead walls to assist with the functionalityof the scanner and housing the scanner on the bottom floor of Lion Heart’s new two-story office. Also in2004, Dr. Simba formed Lion Imaging, a limited liability company, to manage the CT scanner, Dr. Simbawas the sole owner of Lion Imaging and one of its three managing members.Lion Heart’s Reported Income and Claimed DeductionsAs sole owner and manager of Lion Heart and Lion Imaging, respectively, Dr. Simba maintained separatedbooks for both entities. For the years at issue Lion Heart reported income generated by the CT scannerfor patients’ use of its heart scanning service, while Lion Imaging claimed depreciation deductions forthe CT scanner. Lion Heart also claimed deductions related the CT scanner including: (1) salaries andwages of three employees involved in the operation of the CT scanner; (2) repairs and maintenance ofthe CT scanner and the office shared by Lion Imaging and Lion Heart; (3) monthly rental of the sharedoffice; (4) depreciation of the office furniture in the shared office; (5) rental payments on the CT scannerlease; and (6) expenses for operating the CT scanner. In addition, Lion Heart was the sole tenant of theoffice space in which the CT scanner operated, and made the down payment and paid the constructioncosts related to the CT scanner. Simultaneously, Lion Imaging was claiming depreciation on the CTscanner as if it owned the scanner.For the years as issue the Simbas and Lion Heart has the same accountant prepare their tax returns.
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