DocketNumber: Docket Nos. 4171-86, 8169-87
Judges: GOLDBERG
Filed Date: 5/3/1994
Status: Non-Precedential
Modified Date: 11/21/2020
MEMORANDUM OPINION
GOLDBERG, Addi- tional Additions to Tax Interest Docket Sec. Sec. Sec. Sec. Sec. No. Year Deficiency 6653(a)(1) 6653(a)(2) 6659 6661 6621(d) 4171 1981 $ 11,967.10 $ 598.36 $ 627.30 - -86 8169 1982 40,749.00 2,037.45 1,716.00 $ 1,459.25 -87
*198 At issue in this proceeding are the portions of the deficiencies, additions to tax, and additional interest determined by respondent, which are attributable to petitioner's claimed loss and investment tax credit from a master recording leasing program known as the Mid-South Music Corp.Master Recordings Lease Program (the Mid-South program). *199 claimed with respect to his lease of a master sound recording; (2) whether petitioner is liable for the additions to tax for negligence, valuation overstatement, and substantial understatement, and additional interest under
*201 Thereafter, Mr. Butrum discussed the sale of the master with Mr. Inman, whom he had known for a number of years, and informed him that the master could be purchased for $ 25,000. Mr. Inman told Mr. Butrum that Raymond Smith might be interested in buying the master. The master was acquired from Dee Cee by Kin-Folk Music, Inc. (Kin-Folk) for $ 25,000, pursuant to a purchase agreement dated December 31, 1981, signed by Raymond Smith as president of Kin-Folk.
Kin-Folk, in turn, transferred the master to Mid-South under an agreement dated the same day, December 31, 1981, for the stated sum of $ 2,000,000, to be paid $ 25,400 in cash or certified check, and a promissory note in the amount of $ 1,974,600. No payment of principal or interest was due on the note for 12 years, except payment of 25 percent of the gross receipts Mid-South was to receive as rentals after the twelfth month from the date of the note.
The lease agreement with Mid-South called for payment of "minimum rent first fifteen months" in the amount of $ 8,571.43 for the one-seventh interest in the master. Petitioner executed a promissory note dated December 31, 1981, payable to Masters Financial, Inc., for his half*202 of the $ 4,285.72 lease payment. An election was made to transfer investment tax credits attributable to the lease from the lessor to the lessee.
On December 12, 1981, a manufacturer-distribution agreement (the distribution agreement) was executed with Romulus Records, Inc. (Romulus), granting a non-exclusive license to Romulus to manufacture and distribute recordings from the master. The distribution agreement called for payment of $ 1,428.57 (for the one-seventh interest) and 50 percent of the net receipts from sales with respect to the master. Petitioner executed a promissory note to Masters Financial on December 31, 1981, in the amount of $ 714.28 for his one-half of the payment to Romulus.
Mid-South provided petitioner two appraisals of the master. The appraisal by Lawrence Broderick, dated December 14, 1981, concludes that the fair market value of the master on that date was $ 2,000,000. The appraisal by David Mathes also specifies that the value of the master as of December 1, 1981, was $ 2,000,000. Neither of the Mid-South appraisers testified at trial, and petitioner presented no expert witnesses or other evidence to support the claimed value of the master. Respondent's*203 expert witness, Richard Heard, produced a report appraising the one-seventh interest in the master at $ 875. Respondent argues that the fair market value of the master was $ 25,000, the amount paid to the original owner, Dee Cee Productions, Inc., in an arm's-length transaction in December 1981. We agree with respondent, and find that the fair market value of the master in December 1981, was $ 25,000.
Petitioner bears the burden of proving that he is entitled to the claimed credit and deductions. Rule 142(a).
Before determining whether a particular activity arises from or is connected with a trade or business, it must first be established that the transaction in question is bona fide and not a sham. A sham transaction is one that lacks economic substance beyond the creation of tax benefits.
We have examined the substance of the Mid-South transactions and conclude that they had no practicable economic effect other than*204 the creation of tax benefits. In reaching this conclusion, we found the following factors significant: (1) Tax benefits were the focus of the Mid-South promotional materials; (2) there is no evidence of negotiation of the price or terms of purchase between petitioner and Mid-South; (3) the value of the leasehold interest was substantially overvalued; (4) the master was acquired by Kin-Folk for $ 25,000 on the same date it was sold to Mid-South for a stated purchase price of $ 2,000,000; and (5) the bulk of the consideration was deferred by promissory notes that in substance or in fact were not likely to be paid.
We find that petitioner's leasing activity was devoid of economic substance, lacked profit motive, and should be disregarded for tax purposes. Therefore, petitioner is not entitled to deductions for the lease payment made to Mid-South or the distributor fee paid to Romulus, and is not entitled to an investment tax credit.
The next issues are petitioner's liability for additions to tax for negligence under
The loss and credit petitioner claimed with respect to the Mid-South program are based in large part on a purported loan which lacked economic substance. Petitioner contends that he was not negligent because he relied upon the attorneys who supplied tax opinions to Mid-South. While there are situations where reliance on expert or professional advice may satisfy the reasonable and prudent person standard, a taxpayer must establish that the person upon whom he or she relied is qualified to give*206 the advice. Further, the taxpayer must show that the adviser had sufficient knowledge of the facts to render a competent opinion.
Respondent determined that petitioner is liable for the addition to tax under
Petitioner based his investment tax credit on the master's claimed cost of $ 2,000,000. When a transaction lacks economic substance,
Respondent determined that petitioner is liable for increased interest under
Respondent's opening statement on the record suggested that this case was an appropriate one in which we should require petitioner to pay a penalty under (1) Procedures instituted primarily for delay, etc. -- Whenever it appears to the Tax Court that -- (A) proceedings before it have been instituted or maintained by the taxpayer primarily for delay, (B) the taxpayer's position in such proceeding is frivolous or groundless, or * * * the Tax Court, in its decision, *212 may require the taxpayer to pay the United States a penalty not in excess of $ 25,000.
The record in this case establishes that petitioner had reason to know his position would not be successful. The United States District Court for the Middle District of Tennessee issued a Memorandum Opinion on September 20, 1985, finding that Mid-South and Mr. Inman, in organizing and promoting the Mid-South Music Corporation Recordings Lease Program in 1980, and similar programs in 1981-1983, inclusive, had promoted an abusive tax shelter within the meaning of section 6700. Both Mid-South and Mr. Inman were enjoined by the District Court from promoting the Mid-South master recording leasing program.
A petition to the Tax Court is frivolous if it is contrary to established law and unsupported by a reasoned, colorable argument for change in the law.
1. All section references are to the Internal Revenue Code in effect for the years in issue, unless otherwise indicated, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
1. 50 percent of the interest due on the deficiency.↩
2. 120 percent of the interest due on $ 3,963.↩
3. 50 percent of the interest due on $ 11,558.↩
4. 120 percent of the interest computed on $ 5,712.↩
2. The remaining determinations in the notice of deficiency were not considered at the trial of the Mid-South Music Corp. issues.↩
3. Respondent's determinations attributable to the Mid-South program for petitioner's 1981 taxable year are the disallowance of a claimed Schedule C loss in the amount of $ 5,000, consisting of lease expenses and advertising expenses in the respective amounts of $ 4,285 and $ 714, and disallowance of investment tax credit in the amount of $ 14,286. The determination attributable to the Mid-South program for petitioner's 1982 taxable year is disallowance of petitioner's carryforward of investment tax credit from 1981 in the amount of $ 12,195.↩
4. This issue was raised in respondent's amended answer.↩
5. The lease agreement and other documents pertaining to the master recording were originally executed by John W. Olive on behalf of Masters Financial, Inc., and concern a one-seventh interest in the master. Petitioner testified that Master Financial, Inc., was erroneously identified as the lessee instead of petitioner and Mr. Olive individually, and that the error was corrected by amended documents reflecting petitioner's one-fourteenth individual interest. In her brief, respondent notes that "for purposes of this case, respondent will assume that the leasehold interest at issue should have been in the name of petitioner and Mr. Olive and not their corporation, Masters Financial, Inc." Accordingly, for convenience, petitioner will be referred to as the party in interest in our discussion of the various documents involved, although such documents were executed in the name of Masters Financial, Inc.↩
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