MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge: Respondent determined a deficiency in petitioners' 1981 Federal income taxes in the amount of $ 2,776. At trial, respondent moved that the Court determine that*256 the entire 1981 deficiency was attributable to a tax motivated transaction under
FINDINGS OF FACT
Preliminary Matters
This is the lead case concerning the validity of losses and investment tax credit claimed by the partners of the Partnership. Some of the facts have been stipulated*257 and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
John D. Upham (John) and Marion B. Upham (Marion), husband and wife, timely filed a joint Federal income tax return for 1981. Marion died prior to the filing of the petition herein; John is the Personal Representative of Marion's estate.
John, a patent attorney, individually acquired an interest in the Partnership. The Partnership reported a loss for 1981 in the amount of $ 5,860,810, of which John claimed $ 76,530 as his distributive share. Attached to petitioners' 1981 tax return was Form 3468 (Computation of Investment Credit) which showed a $ 6,603 tentative investment tax credit available with respect to John's interest (as a limited partner of the Partnership) in the film. Petitioners were unable to utilize such credit in 1981 because they reported no tax due to the fact they reported a negative amount as their 1981 taxable income.
Hereinafter John will be referred to as petitioner. Petitioner resided in St. Louis, Missouri, at the time the petition herein was filed.
The Limited Partnership
The Partnership was organized as a limited partnership*258 under the laws of the State of New York on March 23, 1981; Daniel Glass (Glass) and Frank Menke (Menke) were its general partners.
Pursuant to a Private Offering Memorandum dated May 27, 1981, the Partnership offered for sale twenty five limited partnership units. Petitioner purchased one-third of one unit on August 14, 1981. He contributed cash in the amount of $ 20,333 and executed two promissory notes. One note, payable on January 10, 1982, was in the amount of $ 20,000; the other, payable on January 10, 1983, was in the amount of $ 18,333. Each note was secured by an irrevocable letter of credit.
In addition to his capital contribution, petitioner executed a Recourse Purchase Note Assumption Agreement (Assumption Agreement). Under the Assumption Agreement, petitioner assumed the primary obligation to pay his pro rata share (i.e., $ 78,726.67) of the principal amount of the Partnership's $ 6,025,000 purportedly recourse promissory note payable to Orion Pictures Company (Orion).
General Partners
As general partners of the Partnership, Glass and Menke negotiated with Orion for the acquisition of the film.
Daniel Glass, a practicing attorney, has had significant*259 experience in the motion picture industry. 2 In the five years preceding the film transaction involved herein, Glass was a general partner or organizer of various partnerships which financed the production or purchase of at least 15 motion pictures.
Frank Menke, an investment advisor, had acted as general partner of a partnership which furnished advertising services for another film entitled "Excalibur."
The Film
The film was produced by LAH Film Corporation for Orion. It is based upon actual events and involves police and judicial corruption and the narcotics traffic in New York City. The focus of the film is principally on the disclosures made by a member of the undercover narcotics squad and the psychological and emotional pressures he endured, as an informant, as he is forced to reveal more and more of the corrupt activities of his partners*260 and close personal friends on the squad whom he originally vowed to protect. It was shot betwen March and June, 1980, entirely on location; it was directed by Sidney Lumet and starred Treat Williams and Jerry Orbach. The screenplay was written by Jay Presson Allan. The film went into nationwide release on August 19, 1981, at over 1,000 theatres.
Purchase Agreement
After viewing a private screening of the film, Glass became interested in acquiring it. On May 29, 1981, the Partnership entered into an agreement (Purchase Agreement) with Orion to acquire the film for $ 11,875,000, which amount was warranted to be the cost to produce the film exclusive of studio overhead charges and production financing.
The purchase price was payable as follows: (1) $ 100,000 cash at closing (August 19, 1981); (2) $ 1,400,000 cash on February 1, 1982; 3 (3) delivery of a promissory note in the amount of $ 6,025,000 with interest at 9 percent per annum, due January 10, 1990, purportedly recourse as to repayment of principal and nonrecourse as to repayment of interest (Recourse Note); and (4) delivery of a nonrecourse promissory note in the amount of $ 4,350,000 with interest at 9 percent*261 per annum, due January 10, 1990 (Nonrecourse Note). No payment of either principal or interest was due on either the Recourse Note or Nonrecourse Note until January 10, 1990.
Under the Purchase Agreement, Orion sold all of its right, title and interest in and to the film, subject to the rights of certain persons to deferments and contingent payments out of the flim's gross receipts, excepting the following rights:
(a) Any of the literary, dramatic and/or musical material contained in the Picture or upon which the Picture is based and the copyrights thereto and any renewals and extensions thereof (all said literary, dramatic and/or musical material being hereinafter collectively called the "Property"), except to the extent necessary to allow [the Partnership] to distribute the Picture throughout the universe;
(b) Any television series rights, so-called television "special" rights, remake or sequel rights, or any other ancillary rights and/or allied rights (including, without limitation, theatrical stage rights) but specifically excluding the benefits of any merchandising and commercial tie-in*262 rights, and music publishing and sound track album rights, which are included in the grant hereunder;
(c) The right to enter into agreements with respect to the Property.
(d) Any option rights with respect to the services of any person rendering services in or with respect to the production of the Picture.
The rights acquired by the Partnership included:
The negative and positive prints, soundtrack and all other pre-print physical material pertaining to the film, the copyright and the right to secure copyright and extensions and renewals thereof, all of [Orion's] rights in the literary, dramatic and musical material used therein as may be necessary to permit the exploitation of the film in all media, [Orion's] sole, exclusive and irrevocable right, license and privilege, under copyright and otherwise, to rent, lease, license, exhibit, distribute, reissue and otherwise to deal in and with respect to the film and any part thereof, prints thereof and trailers thereof and to sublease or license others so to do throughout the universe in any and all languages, and including, but not limited to, cut-in, superimposed, dubbed and synchronized versions, all of [Orion's] so-called*263 "theatrical" rights, "nontheatrical" rights, and "television" rights in the Picture; * * *.
Distribution Agreement
Concurrently with its purchase of the film from Orion, the Partnership entered into a distribution agreement (Distribution Agreement) with Orion pursuant to which Orion had the exclusive rights to distribute and exploit the film throughout the world in all media for an initial period of 12 years with an option for an additional 12 years and thereafter an option to extend the distribution grant in perpetuity. Prior thereto, on March 1, 1978, Orion had granted a license to Warner Bros. Inc. to distribute all motion pictures produced, financed or otherwise acquired by Orion. Thus, actual distribution of the film was through Warner Bros. Inc. (Warner Bros.)
Pursuant to the Distribution Agreement, Orion had the right to edit the film, change the film titles, make foreign language versions of the film, exhibit the film at film festivals, and display its logo in the film credits and in connection with advertising the film.
The Distribution Agreement provided that although Orion would consult with the Partnership with respect to advertising and promoting the*264 film and its release pattern, Orion's decisions would be final and binding. Thus, Orion had, in effect, absolute control over the exploitation of the film, and in fact, the film was promoted as "an Orion Pictures Release Through Warner Bros., a Warner Communications Company."
The Distribution Agreement provided for an allocation of gross receipts, i.e., the aggregate amount received by the distributor from all sources including domestic and foreign theatrical distribution, home video sales and rental, cable TV rentals and commercial TV rentals. The allocation of gross receipts between Orion and the Partnership was based on complex computations. Cutting through the complexities, the Partnership was entitled to receive:
(a) 3.5% of the first $ 15 million in gross receipts, plus
(b) 7.5% of gross receipts in excess of $ 15 million until breakeven is reached, plus
(c) 8.2% of gross receipts in excess of breakeven.
Orion was entitled to receive the remainder.
The Distribution Agreement obligated the Partnership to spend $ 4,000,000 to advertise the film. In addition to the $ 4,000,000 to be spent by the Partnership, Orion agreed to spend an additional $ 7,875,000 to advertise*265 the film. In the event Orion failed to spend $ 7,875,000 by December 31, 1982, then Orion was obligated to pay the Partnership on January 10, 1990, as an additional license fee, a sum equal to the difference between $ 7,875,000 and the amount it actually expended (Additional License Fee).
Expenses paid for advertising the film through December 31, 1981 totaled $ 3,391,521. An additional $ 650,206 was spent in 1982. Thus, the expenses paid to advertise the film through December 31, 1982 totaled $ 4,041,727, with Orion actually spending $ 41,727 of this amount.
The Distribution Agreement further provided that the Partnership was entitled to receive from Orion, by January 10, 1990, to the extent of and to be applied against the balances due on the Recourse and Nonrecourse Notes, an amount equal to 100 percent of the film's gross receipts derived prior to December 31, 1982, plus reduced multiples (ranging from 5.5 to .7) of gross receipts derived between 1982 and 1989. As a result of this provision (the multiplier clause), if the gross receipts of the film generated over an 8 year period totaled approximately $ 1,500,000; the Partnership's obligation to Orion under the Recourse*266 Note (and petitioner's and the other partners' obligations under the Assumption Agreement) would be satisfied. As of December 31, 1981, the film's gross receipts totaled $ 3,315,285.
Miscellaneous Agreements
On July 31, 1981, the Partnership borrowed $ 2,350,000 from Chemical Bank (Marketing Loan) and executed a nonrecourse promissory note for such amount payable on January 10, 1984 (Marketing Loan Note). The proceeds of the Marketing Loan, together with $ 1,650,000 from capital contributions to the Partnership, were used to meet the Partnership's $ 4,000,000 advertising obligation under the Distribution Agreement.
Pursuant to an Assignment Agreement dated as of July 31, 1981 (Assignment Agreement), the Partnership assigned its right to the first $ 2,350,000 of gross receipts as security for the Marketing Loan. Under the Assignment Agreement, Orion agreed to make payment of the foregoing amount directly to Chemical Bank on January 10, 1984, to the extent then earned. Orion further agreed to make the interest payments on the Marketing Loan. By letter dated July 31, 1981, Warner Brothers guaranteed the foregoing obligations of Orion.
Under the Distribution Agreement, *267 the Partnership's obligation to pay interest with respect to the Marketing Loan Note was satisfied out of the gross receipts to which it was entitled. If such receipts were less than the amount of interest due on the Marketing Loan Note, then Orion agreed to advance the difference as a non-interest bearing nonrecourse loan to the Partnership with the right to recoup any payment from future receipts otherwise due the Partnership.
In addition to the Marketing Loan, Chemical Bank agreed to loan the Partnership up to $ 2,472,500. On July 31, 1981, the Partnership borrowed $ 1,642,116 (of the available $ 2,472,500) and executed a promissory note for such amount payable in two installments, January 10, 1982 and January 10, 1983 (Additional Financing Loan). Petitioner executed an Additional Financing Loan Assumption Agreement pursuant to which he assumed an obligation to repay a percentage of the Additional Financing Loan equal to his share in the Partnership.
Results
The parties seemingly agree, and the Partnership's private offering memorandum so stated, the film would have to generate gross receipts of $ 45,000,000 in order for the limited partners in the Partnership to*268 fully recoup their investment. The private offering memorandum informed the investors that only a small percentage of films achieved gross receipts of $ 45,000,000. The film was not a financial success; gross receipts as of December 31, 1985 totaled $ 11,880,063.
Subsequent to the film's release in August, 1981, the general partners became displeased with the advertising and distribution efforts being made by Orion. The general partners consulted with the law firm of Hess, Segall, Guterman, Pelz and Steiner to review the feasibility of instituting litigation against Orion and Warner Bros. The general partners decided against commencing a lawsuit after their attorneys advised that the probability of success did not warrant the costs of prosecuting the lawsuit.
The Partnership did not earn any income in 1981. During the period 1981 through 1985, the Partnership reported losses as follows:
| Year | Loss |
| 1981 | $ 5,860,810 |
| 1982 | 2,696,483 |
| 1983 | 2,487,062 |
| 1984 | 175,567 |
| 1985 | 2,586,137 |
On its 1981 partnership tax return, the Partnership deducted the following:
| Deductions | Amount |
| Interest | $ 16,092 |
| ACRS deductions | 1,789,500 |
| Amortization | 35,119 |
| Advertising | 4,000,000 |
| Tax Advice | 20,000 |
| Miscellaneous | 99 |
| Total Deductions | $ 5,860,810 |
*269 The Partnership depreciated the film under the Accelerated Cost Recovery System (ACRS) and treated the film as 5 year recovery property with a depreciable basis of $ 11,930,000. The Partnership claimed a qualified investment of $ 5,053,333 for investment tax credit purposes. It also deducted a $ 20,000 legal fee paid to the law firm of Arnold & Porter for a tax opinion which was contained in the Private Offering Memorandum.
OPINION
Respondent's initial argument is that the Partnership did not acquire an ownership interest in the film as the transaction was in fact devoid of economic substance. Respondent alternatively asserts that the Partnership, at most, acquired a speculative future profits interest in the film. Petitioner, on the other hand, contends that the substance of the transaction comports with its form, and the Partnership did in fact acquire the film from Orion.
Whether the Partnership became the owner of the film for tax purposes as a result of the transactions with Orion is a question of fact to be determined by reference to the written agreements and the attendant*270 facts and circumstances.
The term "sale" is given its ordinary meaning for Federal income tax purposes and is generally defined as a transfer of property for money or a promise to pay money.
The transfer of title to a motion picture is accomplished through the transfer of both the negative and the copyright. Ownership of a motion picture negative is distinct from ownership of the copyright thereto (
Copyrights are monopolies; "they entitle the owner to prohibit various kinds of reproduction, and to relieve individuals of these prohibitions by licenses."
The sale of a motion picture for Federal tax purposes occurs when there is a transfer of all substantial rights of value in the motion picture copyright. No sale occurs if the transferor retains proprietary rights in the motion picture.
The pertinent factors for consideration, as outlined in
(1) whether legal title passes; (2) the manner in which the parties treat the transaction; (3) whether the purchaser acquired 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 will receive any benefit from the operation or disposition of the property. See
Respondent asserts that petitioner, in his capacity as a limited partner of the Partnership, did not purchase an ownership interest in the film as the transfer of legal title, though in the form of a sale, was devoid of all commercial, legal and economic reality. We agree in part. In our opinion, petitioner did not acquire an ownership interest in the film; however, we believe the transaction between the Partnership and Orion was not devoid*275 of commercial, legal and economic significance. We are satisfied that the negotiations by the Partnership's general partners on behalf of the Partnership were arm's-length dealings. Furthermore, we are satisfied that the amount paid for the film ($ 11,875,000) aproximated its value at the date of transfer. Compare
In our opinion, the Partnership had an opportunity to realize an economic gain which we believe is indicative of the Partnership's having a true financial interest in the exploitation of the film. Hence, we believe the Partnership acquired a speculative and limited future profits interest in Orion's exploitation of the film, as opposed to an ownership interest in the film.
The record clearly reveals that any rights which Orion may have conveyed to the Partnership either were granted back to Orion by virtue of the Distribution Agreement or were of no apparent commercial value. The Partnership transferred to Orion all the basic rights associated with a copyright retaining a mere "bare" copyright. The integrated transfers between the Partnership*276 and Orion resulted in Orion's having the rights to make copies of the film, to exhibit the film, and to otherwise exploit any dramatic material or literary material upon which the film was based. In fact, the film was promoted as "an Orion Pictures Release." Orion held rights to theatrical exploitation, pay television, video cassettes, and commercial television throughout the world. Such enumerated rights combined with the sequel rights retained by Orion provided Orion with the entire bundle of rights that is a copyright.
We have no doubt but that Orion, rather than the Partnership, would be the primary beneficiary of the film's financial success. The terms of the Distribution Agreement, though convoluted and complex, clearly indicate this to be the case. We conclude, therefore, that the Partnership merely acquired an intangible contract right to participate in the profits from the exploitation of the film. 4
*277 Because Orion was the actual owner of the film, the Partnership is not entitled to claim depreciation or cost recovery deductions with respect to the film. The Partnership is, however, entitled to depreciate its intangible contract right to participate in the gross receipts generated from Orion's distribution efforts.
We next must decide whether the Partnership can include the Recourse Note and Nonrecourse Note in its depreciable basis in the intangible contract right. In our opinion, neither of these notes represent genuine indebtedness and thus cannot be included in basis.
With respect to the inclusion of the Nonrecourse Note in depreciable basis, the obligation of the Partnership was payable solely from the Partnership's allocated share of the film's gross receipts. While the use of a nonrecourse note in a sale/leaseback context does not necessarily deprive the debt of its character as genuine indebtedness, such transactions are subject to special scrutiny due to the obvious*278 opportunities for "trifling with reality."
With respect to the inclusion of the Recourse Note in depreciable basis, petitioner executed an Assumption Agreement pursuant to which he purportedly became personally obligated to pay off his pro rata share of the Recourse Note. Respondent asserts that the Assumption Agreement is without economic substance because at the time it was executed petitioner and the other limited partners did not expect Orion to enforce it, and that therefore, they would not*279 be called upon to pay off their pro rata shares of the Recourse Note. We agree.
As a result of the multiplier clause, the $ 6,025,000 obligation purportedly owed by the Partnership to Orion under the Recourse Note effectively would be satisfied if the film produced gross receipts of $ 1,500,000. In our opinion, it was unrealistic to believe that the film would not produce gross receipts of $ 1,500,000 over an 8 year period. Our belief is based on the fact that the film: (1) was a major feature-length motion picture that cost $ 11,875,000 to produce, (2) had an initial advertising budget of over $ 4,000,000 (and an eventual advertising budget of $ 11,875,000), and (3) went into nationwide release at over 1,000 theaters. In fact, petitioner's own expert projected that the film would produce gross receipts of $ 45,000,000.
Petitioner failed to provide any plausible business reason to justify the multiplier clause. 5 The apparent inference to be drawn from the multiplier clause is to exculpate the limited partners of the Partnership from any real monetary exposure under the Recourse Note.
*280 In addition, the Distribution Agreement required Orion to pay the Partnership, on January 10, 1990, an amount equal to the difference between $ 7,875,000 and the actual advertising expenses incurred by it prior to December 31, 1982. We believe it unlikely that if the film did not generate gross receipts of at least $ 1,500,000 by December 31, 1982, Orion would spend $ 7,875,000 to advertise the film; and if Orion did not spend such an amount (which in fact it did not), then it (Orion) had to pay the Partnership the Additional License Fee which would be applied to offset the Partnership's obligation to Orion under the Recourse Note. Accordingly, we find that the Recourse Note was not genuine. And as an aside, the fact that the fair market value of the film approximated the purchase price for the film ($ 11,875,000) is not determinative as to whether the Recourse Note was genuine because we have concluded that the Partnership did not purchase the film for Federal tax purposes.
Since neither the Recourse Note nor the Nonrecourse Note represents genuine indebtedness, the Partnership's basis in its intangible contract right to*281 participate in the gross receipts of the film is limited to the cash portion of the purchase price paid for its contract right.
The next issue for decision is the allowable method of depreciation. On its 1981 return, the Partnership claimed ACRS deductions for the film as five year recovery property. The Partnership acquired an intangible contract right which is not recovery property within the meaning of section 168(c); thus, the Partnership is not entitled to the claimed ACRS deductions.
The Partnership is, however, entitled to depreciate its interest acquired from Orion utilizing the straight-line method of depreciation.
We next consider respondent's contention that the Partnership's motion picture activity was not an activity engaged*282 in for profit. The threshold test for determining whether an activity is engaged in for profit under
Based upon the record before us, we find that the Partnership's motion picture activity was an activity engaged in for profit. Glass was experienced in the negotiation of motion picture purchase and distribution agreements. He had organized other successful motion picture partnerships. Given the inherent risks in the motion picture industry, the facts surrounding the production and distribution of the film indicate a reasonable prospect of profit.
After seeing a private screening of the film, Glass, on behalf of the Partnership, elected to invest in the film which starred experienced actors and involved an experienced and respected director and a well known screenwriter. The film was to be distributed by Orion through the distribution network of Warner Bros. Production costs were warranted to be not less than the purchase price paid by the Partnershsip. The film opened in wide release. As of December 31, 1985, the film had generated gross receipts*284 of $ 11,880,063. Consequently, we find that the Partnership's activity with respect to the film was one engaged in for profit under
We next address whether advertising payments incurred by the Partnership were deductible in 1981. Respondent determined that advertising payments made by the Partnership in 1981 were not currently deductible because they were part of the purchase price and therefore should be capitalized. Respondent contends that the advertising expenses were actually part of the cash down payment for the film, although they were described as advertising payments in order to provide a current deduction. Petitioner argues that the advertising expenses were deductible by the Partnership as ordinary and necessary business expenses under section 162(a).
Based on the record before us, it appears that the Partnership did not incur the advertising expenses. Invoices for advertising services were submitted to Orion and/or Warner Bros. and were paid from a special bank account at Chemical Bank created for this purpose. Warner Bros. employees had authority to sign checks paying for the advertising services. Amounts paid for advertising by Warner Bros. were*285 reimbursed to it by writing checks on this special bank account.
With respect to the Marketing Loan, we conclude that such loan was not a bona fide debt of the Partnership. Orion and/or Warner Bros. effectively guaranteed the Partnership's purported debt obligation under the Marketing Loan Note to Chemical Bank.
Further, it appears to us that the purpose of the Partnership's $ 4,000,000 advertising advance (such sum being comprised of proceeds from the Marketing Loan and $ 1,650,000 from cash capital contributions) under the Distribution Agreement was to transform a capital investment into a current deduction. Orion had complete control of the funds once they had been provided by the Partnership. Orion independently made the decisions regarding the use of the funds for advertising. Under the "advertising clause" in the Distribution Agreement, the Partnership was entitled to recoup sums from Orion as an Additional License Fee in the event Orion failed to meet its advertising expense commitment. Accordingly, as the Partnership was not itself incurring advertising expenses, petitioner is not entitled to deduct any portion of the amounts claimed by the Partnership as advertising*286 expenses. The $ 1,650,000 of the advertising advance is to be added to the Partnership's depreciable basis in its intangible contract right.
The next issue we must decide is the deductibility of the $ 20,000 legal fee paid to the law firm of Arnold & Porter for its tax opinion contained in the private offering memorandum. Petitioner asserts that the fee paid to Arnold & Porter is a deductible business expense under section 162 or alternatively, an organizational expense under
Payments allocable to organization costs and syndication expenses must be capitalized. Organization costs, if elected, are amortizable over a 60-month period, but syndication costs are not amortizable.
As to the $ 69,120 substantiation issue, petitioner presented the testimony of Glass at trial. Petitioner claims that the $ 69,120 sum represents*288 management fees which were paid to Glass by crediting his capital account for such amount. There is no documentary evidence or testimony before us to indicate that Glass reported such sum as income. In this respect, the rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable.
As to the remaining amount claimed by the Partnership as amortizable organizational*289 expenses, petitioner must establish that portion of the expenses allocable to nondeductible capital expenditures and that portion allocable to deductible expenses.
Because this opinion will determine the validity of the investment tax credit claimed by other partners of the Partnership, we deem it appropriate to address, and thus we shall decide, whether the Partnership is entitled to an investment tax credit with respect to its acquired interest in the film, notwithstanding the fact that in 1981 (the only year at issue) petitioner was unable to utilize his distributive share of the investment tax credit claimed*290 by the Partnership with respect to its purported investment in the film.
Orion filed an election with the Internal Revenue Service to assign a portion of the investment tax credit with respect to the film to the Partnership. The Partnership then reported in its 1981 tax return a qualified investment in the film for investment tax purposes.
Respondent asserts that no investment tax credit is available because the purported acquisition of the film by the Partnership had not been completed by the date the film was released. He alternatively asserts that the partners are not entitled to an investment tax credit because the Partnership did not have any "ownership interest" in the film within the meaning of
Respondent's argument that the release of the film preceded the Partnership's acquisition of its intangible contract right essentially challenges whether the acquired interest in the film was new
Respondent contends that if the Partnership acquired an ownership interest in the film, it did not do so until after the film was released on August 19, 1981. Glass testified at trial that the acquisition of the film was consummated on the morning of August 19, and the film was released later that night. Although the closing of the Partnership's transaction was delayed until August 19, we find that petitioner has met his burden of proof and that the contract right acquired by the Partnership is new
A*292 taxpayer is entitled to an investment tax credit under
A taxpayer may have an "ownership interest" in a motion picture for purposes of the investment credit even if the taxpayer has neither legal title to nor a depreciable interest in the motion picture.
In enacting
Under
We have stated that the "thrust of
We do not read
On the Partnership tax return for 1981, the Partnership claimed $ 16,092 as an interest expense. On brief, respondent*296 has conceded that the Partnership is entitled to deduct this amount under section 163. The Partnership also claimed $ 99 as a miscellaneous expense; we believe respondent has also conceded this amount.
The final issue for consideration is whether petitioner is liable for additional interest on substantial underpayments of tax attributable to tax motivated transactions. As respondent requested the addition to tax by motion filed subsequent to the issuance of the notice of deficiency, he has the burden of proof.
The Treasury Department has promulgated temporary regulations which describe accounting methods which "may result in a substantial distortion of income." See section 301.6621-2T, Q&A-3, Temp. Proced. & Admin. Regs.,
Q-3. What accounting methods may result in a substantial distortion of income for any period under
A-3. A deduction or credit disallowed, or income included, in any of the circumstances listed below shall be treated as attributable to the use of an accounting*298 method that may result in a substantial distortion of income and shall thus be a tax motivated transaction that results in a tax motivated underpayment:
* * *
(4) Any deduction disallowed for any period under
* * *
(9) In the case of a taxpayer who computes taxable income using the cash receipts and disbursements method of accounting, any deduction disallowed for any period because (i) the expenditure resulting in the deduction was a deposit rather than a payment, (ii) the expenditure was prepaid for tax avoidance purposes and not for a business purpose, or (iii) the deduction resulted, in a material distortion of income * * *.
Our first consideration in determining the applicability of the provisions of
Under
*300 Although petitioner was unable to utilize his distributive share of the investment tax credit claimed by the Partnership for 1981, since this is a test case, we believe it appropriate to address whether the Partnership's claimed investment tax credit was the result of a tax motivated transaction.
We have held that the Partnership is not entitled to an investment tax credit with respect to its interest in the film because it did not acquire an ownership interest within the meaning of
We have disallowed the Partnership's claimed deductions for the amortization of organizational expenses and deductions for tax advice because petitioner failed to prove that such amounts were not syndication expenses within the meaning of
The last item disallowed was the claimed deduction for advertising expenses made pursuant to the Distribution Agreement. In substance, the characterization of a payment by the Partnership to Orion as advertising expenses was merely an attempt to convert a capital investment into a current deduction. We view this subterfuge as using the cash receipts and disbursements method of accounting to create a material distortion of income. While we recognize that our actual basis for disallowing the Partnership's claimed advertising expense deduction was that the Partnership did not incur advertising expenses, we believe that the facts leading to this conclusion are so integrally related to the Partnership's attempt to create a distortion of income that the two holdings are inseparably related. See
In order to impose additional interest under
To reflect the foregoing and concessions of the parties,
Decision will be entered under Rule 155.
Footnotes
1. Unless otherwise indicated, all subsequent section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. See
Brown v. Commissioner,T.C. Memo 1988-527">T.C. Memo. 1988-527 ;Evans v. Commissioner,T.C. Memo. 1988-468 ;Vandenhoff v. Commisioner,T.C. Memo. 1987-116 ; andSchwartz v. Commissioner,T.C. Memo. 1987-381↩ , for a more detailed summary of Glass' industry experience.3. Glass testified that the $ 1,400,000 was in fact paid in September, 1981.↩
4. This holding is in accord with our holdings in other cases involving motion picture transactions in which Mr. Glass was involved. See
Brown v. Commissioner,T.C. Memo 1988-527">T.C. Memo. 1988-527 ;Schwartz v. Commissioner,T.C. Memo. 1987-381 n. 25 ;Isenberg v. Commissioner,T.C. Memo. 1987-269 ; andVandenhoff v. Commissioner,T.C. Memo 1987-116">T.C. Memo. 1987-116 . But seeEvans v. Commissioner,T.C. Memo 1988-468">T.C. Memo. 1988-468 , andJacobson v. Commissioner, T.C. Memo. 1988-341↩ , cases with different facts, but involving film partnerships in which Mr. Glass was a general partner.5. On direct examination, Glass testified as follows with respect to the multiplier clause:
Q In the distribution agreement, there is a formula set forth for payments on the recourse note, and it has various multipliers.
Kindly explain the rationale of that section of the agreement.
A Well, that was the result of long, drawn-out negotiations with Orion and Warner Brothers. I had, not many months before, had a deal with Orion on a picture * * * and we had to terminate that transaction shortly before its scheduled closing, because Orion wouldn't assure me that they would file their tax returns in conformity with the understanding that they were selling me the picture; in other words, that they would give up any right to claim depreciation.
And so they were confronted with the fact that they were going to lose the investment tax credit. They were going to lose the right to depreciate, and they wanted to find a formula that would give them some -- way of taking write-offs which would at least correspond to what they would have had, had they retained ownership of the film.
And this formula, since they were on the accrual method of accounting, the formula was designed, as I understood it -- and one would have to ask them, because I can't crawl into their minds, but this is what was explained to me, because their tax people were involved -- that this gave them the opportunity to have fixed and determinable amounts in the years in which they would otherwise be depreciating the film, which they could take as deductions because they were amounts that would be -- * * * -- to Prince Associates until 1990, they could nevertheless accrue them for tax purposes in the year in which they were -- in which the amount was fixed and determinable, from their point of view.
And that's -- so we had this complicated formula.↩
6. We recognize that the Partnership claimed a basis in the film and that we determined that the Partnership had basis in only an intangible contract right. However, analyzing the valuation overstatement from the perspective of the two property rights being identical would require comparing the Partnership's claimed basis in the film to the Partnership's actual zero basis in the film and we would therefore reach the same result. See
Zirker v. Commissioner,87 T.C. 970">87 T.C. 970↩ (1986).