Decision will be entered under Rule 50.
Petitioner, owner of an independent television station, was the licensee of various syndicated and feature films. Petitioner wrote off these films under a method which purportedly related payments to usage. Although petitioner filed its returns on an accrual basis, petitioner claimed in each year as the amount of its writeoff with respect to licensed films the same amount as were its payments to licensors during that year. Held, petitioner's method was not proper.
*717 Respondent determined deficiencies in petitioner's Federal income taxes for the calendar years 1955, 1956, and 1957 in the amounts of $ 45,361.77, $ 21,530.34, and $ 25,880.71, respectively. 1
The only issue remaining for decision *87 is the determination of the proper amount of petitioner's deductions for 1957, 1958, and 1959 with respect to certain television film contracts.
*718 FINDING OF FACTS
Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.
Petitioner is a calendar-year taxpayer. It filed its Federal corporate income tax returns for all periods here involved on an accrual method of accounting with the district director of internal revenue, Tacoma, Wash. Petitioner, a Washington corporation, has its principal place of business in Tacoma.
In addition to operating a newspaper and radio station in Tacoma, petitioner owns and operates a television station, KTNT-TV, in the Seattle-Tacoma area. KTNT-TV first commenced broadcasting in March 1953. Until February 1958 it was affiliated with the CBS network.
In August 1957 CBS had notified petitioner of the impending loss of the station's affiliation with the CBS network. After studying their dilemma, the management of petitioner decided to continue operations as an independent station. The management commenced a program of heavy film buying in order to *88 substitute film material for the lost network programing.
Independent stations such as KTNT-TV have encountered several hurdles in establishing themselves. The significant independents are generally found in the larger markets where there are sufficient populations to sustain more than the three network stations. Independents have had difficulty selling advertising agency representatives the concept of non-network-affiliated stations. Independents also have incurred problems in obtaining at reasonable prices program material which can compete in quality and audience attractiveness with network programing.
Petitioner's station faced the foregoing problems especially during 1958 and 1959. Although the station heavily committed itself to film program material in an effort to maintain a high competitive program level, the station's audience ratings declined substantially. Its advertising revenues also dropped sharply. Consequently, petitioner suffered large net operating losses from operating KTNT-TV during 1958 and 1959.
In 1958 petitioner filed a civil antitrust damage suit against CBS and Queen City Broadcasting Co. of Seattle, whose station KIRO-TV had succeeded to the CBS network *89 affiliation for the Seattle-Tacoma area. On May 20, 1960, the parties to the dispute agreed upon a settlement. Under the terms of the settlement CBS agreed that for a period of 2 years, starting June 1, 1960, and ending May 31, 1962, CBS network programing would be made available for presentation in the *719 Seattle-Tacoma area by both KTNT-TV and KIRO-TV. During the 2-year period, KTNT-TV intermittently carried CBS network programing. On May 31, 1962, CBS permanently terminated its affiliation with KTNT-TV. Since that time KTNT-TV has operated entirely as an independent.
The basic commodity being sold by any television station and being purchased by the buyer of advertising time is a listening audience. Buyers must rely on rating data and other background information to reach conclusions as to the size of an audience which can be expected to view advertising placed at various times of the day on various competing stations. When a station's rating for any given time period drops below a certain minimum, that period becomes noncompetitive. In other words, such time period has little attractiveness to prospective time buyers. Consequently, there is no possibility of the station's selling *90 a significant amount of advertising during that time period. Because of their competitive disadvantages, independent stations normally have substantial portions of their broadcasting day which are noncompetitive. Independent stations generally must concentrate their efforts on selected hours of the program day.
Petitioner's station has followed the policy, as have most independent stations, of maintaining a broadcast day from noon until midnight although the station is not competitive for most of those hours. The general image of the station would be hurt if it were intermittently signing on and off. Also, the ratings of the station would be asterisked in rating books to indicate the station was not in full operation. Advertising agencies would discount the value of the station's ratings in determining whether or not to place advertising on the station.
During 1958 and 1959, its initial years of independent operation, KTNT-TV was able to develop competitive ratings only during 4 hours of its average 12-hour broadcasting day. These hours were 5:00 to 7:00 in the evening and later from 10:00 to midnight. Sales of advertising time during such hours produced the bulk of petitioner's *91 television revenues. The remainder of its time on the air consisted of "fill" programing from which petitioner derived no significant advertising revenue.
A package of films has two principal benefits. The first is the revenue which it will produce. The second is that it furnishes a reservoir of programs for keeping the station continuously on the air.
The film license agreements in issue in this case related to two major categories of film materials. One category consisted of syndicated program series, such as "I Love Lucy." The other category consisted of feature-film packages which were groups of motion-picture films originally produced for theater audiences. All of these license agreements *720 imposed a limitation on the maximum number of months or years during which the materials could be played by petitioner's station. The individual films were usually forwarded from station to station as they were used. Each station had physical possession only long enough to permit the scheduled showing of that particular episode.
Syndicated packages range widely in the number of individual episodes from as few as 30 to as many as 250 or more. The number depends upon the popularity and strength *92 of the particular series. Syndicated packages are usually never available on a single-run basis. They normally permit from two to six runs or showings of each episode during the permissible play period. During the years 1957 through 1959 the syndicated materials for which KTNT-TV contracted varied between 52 and 217 episodes. Each episode usually provided for two or three runs.
Feature-film packages usually range in size from as few as 20 or 30 films to as many as 700. The films in most packages have a broad range in quality. As in the case of syndicated packages, most feature-film packages permit four to six showings of each feature during the contract period. During 1957 through 1959, KTNT-TV's feature-film packages varied in size from 2 films to 100 or more films. The average package was about 40 to 60 films with the range of permissible runs being between 4 and 6. In certain instances during the years at issue, petitioner repurchased additional runs of selected feature films from earlier contracts. Petitioner thereby acquired as many as 10 permissible runs of selected features.
Within a feature-film package approximately one-third of the films are rated A (excellent) or B *93 (good). The remainder are normally rated C, D, and sometimes E (least desirable). The policy of KTNT-TV was to use the first couple of runs of films rated A and B during time periods when the station was competitive. Afterwards, the station would shift such feature films to afternoon showings, the so-called fill time. The lower rated films were never run during competitive time periods. Thus, subsequent showings of top-quality films during noncompetitive time periods would displace presentations of lower rated films. The station therefore never expected to utilize fully the bottom half of a feature-film package. In fact, during the years in issue the station was only utilizing 75 percent of total available usage. In negotiating feature-film packages, the station did not have sufficient bargaining strength to negotiate a lower purchase price in return for agreeing to reduce the permissible runs of a given film. The station also was not in a bargaining position to alter the mix of films presented within a given package.
*721 It is an accepted fact in the television industry that program material loses some of its power to attract and hold audiences with each successive showing in a given *94 market area. That is the reason why top-rated feature or syndicated films are shifted after their initial runs to less important time periods where they serve as "fill." With respect to syndicated materials KTNT-TV would use them in competitive time periods for only the first or second runs.
A study of all the film usage cards relating to the feature film contracts placed at issue disclosed the following information:
| Number | Use | Payment | Actual | |
| Licensor name | feature | term | term | use |
| films | period 1 | |||
| Months | Months | Months | ||
| NTA | 50 | 36 | 26 | 39 |
| Screen Gems | 40 | 48 | 30 | 48 |
| Screen Gems | 52 | 48 | 36 | 48 |
| Screen Gems | 20 | 36 | 24 | 12 |
| Alexander | 8 | 24 | 18 | 22 |
| NTA | 30 | 42 | 27 | 41 |
| NTA | 29 | 42 | 27 | 53 |
| NTA | 26 | 42 | 27 | 39 |
| NTA | 2 | 46 | 24 | 39 |
| NTA | 4 | 42 | 24 | 38 |
| NTA | 24 | at least | 35 | 41 |
| 45 | ||||
| NTA | 22 | 55 | 35 | 53 |
| NTA | 19 | 36 | 35 | 34 |
| NTA | 32 | 50 | 35 | 48 |
| NTA | 63 | 42 | 28 | 41 |
| Corradine | 58 | 36 | 27 | 39 |
| Assoc. Artists | 116 | 48 | 36 | 69 |
| (extended to | 72 | 72) | ||
| Screen Gems | 104 | 36 | 24 | 35 |
| Exhibit | |||
| Licensor name | First use | Last use | No. |
| NTA | December 1957 | March 1961 | 10-J |
| Screen Gems | June 1957 | May 1961 | 12-L |
| Screen Gems | October 1957 | September 1961 | 13-M |
| Screen Gems | February 1961 | January 1962 | 14-N |
| Alexander | July 1957 | May 1959 | 15-O |
| NTA | February 1959 | July 1962 | 16-P |
| NTA | June 1958 | October 1962 | 17-Q |
| NTA | September 1959 | December 1962 | 18-R |
| NTA | November 1958 | February 1962 | 19-S |
| NTA | March 1960 | May 1963 | 20-T |
| NTA | July 1961 | November 1964 | 21-U |
| NTA | May 1961 | October 1965 | 22-V |
| NTA | July 1959 | May 1962 | 23-W |
| NTA | January 1961 | December 1964 | 24-X |
| NTA | October 1959 | March 1963 | 26-Z |
| Corradine | April 1959 | July 1962 | 27-AA |
| Assoc. Artists | September 1957 | June 1963 | 28-AB |
| extended to | |||
| Screen Gems | January 1959 | December 1961 | 30-AD |
Exhibit 21-U referred to above was a contract dated November 22, 1958, between National Telefilm Associates, Inc. (hereinafter referred to only as NTA), and petitioner for telecast over petitioner's facilities of 24 feature films. Each film could be run no more than four times over at least a 45-month period commencing January 1, 1960. The aggregate cost was $ 10,000 payable in 35 monthly installments commencing February 1, 1959. The installments were initially $ 150 per month. They increased to $ 200 per month on January 1, 1960, $ 450 per month on January 1, 1961, and then to $ 500 per month on February 1, 1961. Petitioner paid $ 1,650 in 1959 and claimed that amount as a deduction on its 1959 return as film rental expense.
Other film license agreements placed in issue and of particular importance in the immediate case are described below:
Exhibit 9-I was a contract dated December 5, 1956, between NTA and petitioner for telecast over petitioner's facilities of 86 feature films. Each film could be run no more than six times over a 3-year term commencing January 2, 1957. The aggregate cost was $ 114,000 plus a union payment of $ 6,840. The contract *96 originally provided for 12 *722 monthly payments of $ 4,000 followed by subsequent payments of $ 1,500 per month. The contract was amended in July 1959 with regard to payment of the unpaid balance of $ 12,000. The amendment to the contract stated that the balance would be payable as follows:
$ 2,000.00 on each of July 15, 1959, August 15, 1959; $ 2,770.00 on September 15, 1959; $ 300.00 on each of October 15, 1959, November 15, 1959, December 15, 1959; $ 60.00 on each of January 1, 1960, February 1, 1960, March 1, 1960; $ 1,000.00 on each of April 1, 1960, May 1, 1960, June 1, 1960; $ 75.00 on each of July 1, 1960 and August 1, 1960; $ 500.00 on each of September 1, 1960 and October 1, 1960 until total unpaid balance of $ 12,000.00 is paid in full.
Exhibit 16-P was a contract dated August 25, 1958, between NTA and petitioner for telecast over petitioner's facilities of 30 feature films. The payment schedule included payments of $ 325 each on October 1, 1958, November 1, 1958, and December 1, 1958. The term of the license was 42 months commencing January 1, 1959. The total license fee was $ 39,645 plus a union payment of $ 2,378.70.
Exhibit 39-AM was a contract dated February 27, 1959, *97 between petitioner and Corradine and Associates for telecast over petitioner's facilities of the syndicated series "The Ruggles." There was a downpayment of $ 910. The balance was due in 12 monthly installments of $ 2,000 for the first 3 months, $ 2,400 for the fourth month, $ 3,000 in each of the following 4 months, and then $ 4,000 for each of the remaining 4 months.
Exhibit 41-AO was a contract between Banner Films, Inc., and petitioner for telecast over petitioner's facilities of a syndicated series "Night Court U.S.A." Petitioner commenced showing the series on or after January 1, 1959. Monthly payments of $ 1,365 commenced on October 1, 1958.
During November 1958 petitioner wanted to purchase additional film packages from NTA. In order to pay the approximate purchase price of $ 75,000, petitioner realized it would have to extend its future payments on outstanding packages. As a consequence petitioner wrote NTA:
We have this date concluded a deal for some hand picked Rerun Features, for a total amount of $ 75,000.00, with you, having signed this date a letter of agreement covering said transaction.
In order to be able to add this amount of money to our film budget, it becomes necessary *98 for us to realocate [sic] monies which we now owe you under certain existing contracts with you.
* * * *
The following reallocation of payments have been discussed during our meeting in Tacoma this week, and we would greatly appreciate it, in order for us to be able to enter into the $ 75,000.00 contract, if you would get same approved, subject of course to your home office in New York.
* * * *
*723 Subject to the approval of your home office, we have asked you this date for the following, realocated [sic] payment plan.
| $,3,200.00 | payment for January 1959 | $ 3,200.00 |
| 9,000.00 each | payment for February 1959 and each and every | |
| consecutive month thereafter, up to and including | ||
| the month of December 1960 | 207,000.00 | |
| 2,600.00 each | payment for January 1961 and each and every | |
| consecutive month thereafter up to and including | ||
| the month of December 1961 | 31,200.00 | |
| 241,400.00 |
During the years in issue a total of 135 film contracts were in effect between petitioner and various licensors. Sixty of the contracts related to feature-film packages and the balance to syndicated program series. Respondent has made adjustments to petitioner's deduction with respect to 34 of these contracts. In making these adjustments respondent *99 relied on Rev. Rul. 62-20, 1 C.B. 21">1962-1 C.B. 21. According to that ruling a television station must determine with respect to each contract the maximum number of months which the station has to televise the underlying film materials. The ruling then provides that the station must deduct the total contract price in equal monthly installments over this maximum permissible play period.
On its Federal corporate income tax returns for the calendar years 1957, 1958, and 1959 petitioner deducted $ 128,154.12, $ 235,868.88, and $ 335,435.09, respectively, with respect to payments made as licensee under its various film license agreements. With respect to the adjustments described above, respondent has disallowed $ 49,770.57, $ 87,234.16, and $ 41,404.70 of such deductions for those years respectively. As the result of these disallowances, respondent determined deficiencies in petitioner's Federal income taxes for taxable years 1955, 1956, and 1957. The deficiencies for 1955 and 1956 resulted from adjustments made to operating losses incurred in 1958 and 1959, which adjusted losses were then carried back to 1955 and 1956.
OPINION
The sole issue for decision is whether petitioner, an accrual method *100 taxpayer, overstated its deductions for television film rentals in the taxable years 1957, 1958, and 1959.
This opinion must be presented against the backdrop of KIRO, Inc., 51 T.C. 155 (1968), in which the Court considered the same issue. The dispute in that case focused on three categories of films: (1) 700 Paramount films (1 contract) having limited exposures. (2) 1,407 other films (35 contracts) having limited exposures. (3) Other films (5 contracts) having unlimited exposures. The taxpayer had allocated the cost of each contract to the individual films in the package. The *724 taxpayer then reallocated the cost of each film to its individual showings. The reallocation was done on a sliding scale which provided higher rates to earlier showings. We rejected the straight-line method advocated by the Commissioner and approved the taxpayer's sliding-scale method as to the first two categories of films.
Petitioner has adopted the approach of KIRO, Inc., supra, and has asserted a further method of calculating its deduction in lieu of the straight-line method adopted by respondent in making his determination herein. We have concluded that under the facts presented petitioner has not established *101 that its method was a proper one. Both parties have dealt with the issue involved herein in the context of section 167(a)(1). 2 Under the foregoing circumstances, it is not necessary for us to decide whether that section or section 162(a)(3)3*102 applies. See KIRO, Inc., supra at 167-168; Allen M. Early, 52 T.C. 560">52 T.C. 560, 570 (1969) (dissenting opinion). 4 Whether the claimed method involves depreciation or amortization, petitioner must fail.
Petitioner states that the basic theory underlying its method is to match film costs with predicted film usage. The matching is purportedly accomplished at the contract negotiation stage. Petitioner contends that it negotiates the schedule of payments under each contract to coincide with the projected useful life to it of the film-program materials included within that contract. Consistent with its theory, petitioner deducted each year the same amounts as its payments during said year.
We do not think in actual practice petitioner's schedules of payments coincided with exhaustion *103 of the value of its films. The periods of payment were generally shorter than the permitted periods of usage. The Court recognizes that television films increasingly lose their *725 audience appeal with each successive run. We cannot agree with petitioner, however, that the films usually had been run so many times by the end of the payment period that they held minimal value to the station at that time. Petitioner fails to consider that the films were of significant value as "fill" during the years in issue. Petitioner's station was one of the few in the country that had lost outright its network affiliation. What KTNT-TV needed was material just to sustain its programing from noon to midnight. To achieve that goal, the station promptly purchased large numbers of films. Accordingly, the Court feels that because of the unique unfortunate circumstances of KTNT-TV during the years in issue, reruns of a particular film continued to have value to the station throughout the full term of the license period.
In another respect we find fault with petitioner's method. Under several of the license agreements monthly installments increased in amount as the license periods progressed. For example, *104 in Exhibit 21-U the initial installments were $ 150 per month. Monthly installments in succeeding years increased to $ 200, $ 450, and then $ 500. The same pattern occurred in Exhibit 39-AM. The first three monthly payments were each $ 2,000. Subsequent monthly payments rose steadily to $ 2,400, then $ 3,000, and finally to $ 4,000. Petitioner alleges that under its method the payments coincided with usage. If that is so, and acknowledging the fact that television films diminish in value upon each successive showing, the foregoing payments should have decreased rather than increased.
The film contracts placed in issue reveal two further defects in petitioner's method of allegedly having payments correspond to usage. First, the payments under some contracts sharply fluctuated. It would demand considerable imagination to say that such fluctuation in payments reflected fluctuation in usage. For instance, the payments due under Exhibit 9-I as of July 1959 were:
$ 2,000.00 on each of July 15, 1959, August 15, 1959; $ 2,770.00 on September 15, 1959; $ 300.00 on each of October 15, 1959, November 15, 1959, December 15, 1959; $ 60.00 on each of January 1, 1960, February 1, 1960, March *105 1, 1960; $ 1,000.00 on each of April 1, 1960, May 1, 1960, June 1, 1960; $ 75.00 on each of July 1, 1960 and August 1, 1960; $ 500.00 on each of September 1, 1960 and October 1, 1960 until total unpaid balance of $ 12,000.00 is paid in full.
A second defect of petitioner's method was that payments under some contracts began in the taxable year preceding commencement of the license period. Since petitioner is an accrual method taxpayer, this would be quite improper. For instance, petitioner was entitled under Exhibit 41-AO to telecast a syndicated series "Night Court U.S.A." Although the petitioner did not begin showing the series until 1959 payments commenced in 1958. Likewise, under Exhibit 16-P, *726 a feature-film contract, the license period did not commence until 1959 but payments were made in 1958.
We consider petitioner's method principally a device of cost accounting. For instance, it does not appear that the extensions for payment referred to above were based upon revised estimations of increased usage. Statements in petitioner's correspondence suggested that petitioner requested these payment extensions simply to accumulate more funds to acquire additional films.
Petitioner *106 adopted a group or composite procedure instead of allocating the total cost of a particular contractual package to its individual feature films. 5 We do not think such method was correct.
A composite writeoff rate must necessarily raise the question whether it reaches a reasonable result. In deciding that question we have considered that the quality mix of films encompassed within a feature-film contract is quite diverse. The ratings of films vary from A (excellent) to E (least desirable). The A films will be shown at least once during prime viewing hours. Gradually they will be shifted to less popular hours. On the other hand, E films might never be shown at all. In negotiating its contracts, petitioner's station had no choice as to the mix of films offered by the distributor under a given contract. Under the facts presented we do not regard the composite or group procedure appropriate for writing off petitioner's licensed feature films. *107 The films within the licensed packages were too diverse as to quality.
Petitioner strongly contends that its composite method is an accurate averaging technique which facilitates decisions by senior personnel of the station. As stated above, we do not think petitioner's averaging method is sufficiently accurate as a method of writeoff for Federal income tax purposes. Although the method appears conducive to efficient management decisions, petitioner mistakenly assumes that it is appropriate for tax purposes.
Petitioner cites Portland General Electric Co. v. United States, 189 F. Supp. 290">189 F.Supp. 290 (D. Oreg. 1960), affirmed per curiam 310 F.2d 877">310 F.2d 877 (C.A. 9, 1962). It is petitioner's opinion that the case presents a situation quite similar to the case at bar. The District Court was concerned, among other things, with the taxpayer's writeoff of its mass property accounts. Each account consisted of many units, all having the same function but having different probable lives. Typical of such property accounts were items such as wood poles or overhead lines of distribution. The taxpayer followed a method of writeoff which measured the *727 useful lives of its properties in component groups. The Commissioner *108 rejected that method. He proposed to substitute another method which utilized reconstructed average lives based upon certain extrinsic experience and evidence. The District Court held that the Commissioner was arbitrary and unreasonable in seeking to substitute his method of straight-line average life writeoff for the taxpayer's method of straight-line unit summation.
It is of interest to note that the positions of the parties in the Portland General Electric case were the reverse of those in the instant case. Here it is the taxpayer, and not the Commissioner, who is arguing for a group procedure based on an averaging technique.
We do not consider the District Court's opinion to be support for petitioner's position in the case at bar. In fact, we feel that there are even stronger reasons for rejecting in the instant case petitioner's composite or group method than there were for rejecting the Commissioner's analogous method in the Portland General Electric case. In that case the petitioner was was relying on a long history of past experience whereas the Commissioner relied only on extrinsic evidence developed by an engineer agent. In contrast, the petitioner in our case did not *109 commence acquiring films until the years in issue. Consequently, in the instant case petitioner cannot allege that its method relied on a long history of past experience enjoyed by its station. Furthermore, as we have previously discussed, the films encompassed in a contract were quite diverse. Thus, we cannot look upon the films as being similar in the same sense as were the telephone poles of Portland General Electric Co.
Petitioner submitted no evidence to support a further alternative method (e.g., the method approved in KIRO, Inc., supra) to that upon which respondent's determination is based. Accordingly, in view of our conclusions above, we must sustain that determination.
Decision will be entered under Rule 50.
Footnotes
1. The statutory notice received by petitioner contained adjustments to certain net operating loss carrybacks to 1955 and 1956, as well as similar adjustment for 1957. Because of these adjustments, the Court has jurisdiction under sec. 6213(b), I.R.C. 1954↩, to determine the correctness of respondent's adjustments relating to petitioner's taxable years 1958 and 1959.
1. Figures rounded to nearest month.↩
2. All section references will hereinafter refer to the Internal Revenue Code of 1954 unless otherwise stated.
SEC. 167. DEPRECIATION.
(a) General Rule. -- There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) --
(1) of property used in the trade or business, * * *↩
3. SEC. 162. TRADE OR BUSINESS EXPENSES.
(a) In General. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including --
* * * *
(3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.
4. See also Tom F. Baker III, 38 T.C. 9">38 T.C. 9, 13 (1962), in which we stated: "it may be observed that in reality, from a pure deduction standpoint, it makes no difference in tax liability whether a deduction from gross income is called a business expense and allowed under section 162 or depreciation and allowed under section 167↩. In fact, the cases show that the term given the allowance has been indiscriminately referred to sometimes as expense or amortization n7 and at other times as exhaustion or depreciation. n8" (Footnotes omitted.)
5. Composite or group accounting is generally used where assets are similar in kind. The leading advantage of the procedure is its simplicity in application. A single reserve can be used rather than separate reserves for numerous individual items.↩