77 T.C. 964 (1981), 6004-76, Estate of Helliwell v. C.I.R

Docket Nº:6004-76.
Citation:77 T.C. 964
Opinion Judge:SIMPSON, Judge:
Attorney:Calvin Eisenberg, Donald A. Statland, Robert D. Zimelis, Randall G. Dick, and Alan F. Segal, for the petitioners. James F. Kidd and Janet A. Engel, for the respondent.
Case Date:October 29, 1981
Court:United States Tax Court

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77 T.C. 964 (1981)




No. 6004-76.

United States Tax Court

October 29, 1981

In 1972, C, a limited partnership, contracted to produce two motion pictures for W. For its services, C was to receive a fee, which was, in part, contingent on the commercial success of such motion pictures. W was an experienced producer of motion pictures, but none of the general partners of C had any such experience. C engaged regular officers or employees of W to supervise and make the arrangements for the production of the motion pictures. In addition to the capital contributed by C's partners, financing for such motion pictures was obtained by bank loans. W or C was the principal obligor on such loans; but all the loans were nonrecourse as to C, and W furnished the security for all the loans. H was a partner in C, and on his 1972 return, claimed a deduction for his pro rata share of the expenses incurred in the production of such motion pictures. Held : W, and not C, was the actual producer of such motion pictures and was the actual borrower of such bank loans. C's sole function with respect to the production of the motion pictures was to provide additional financing, and C's partners, in substance, purchased a net-profits interest in such motion pictures. Accordingly, H is not entitled to deduct in 1972, or any later year, his pro rata share of the expenses incurred in producing such motion pictures.

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Calvin Eisenberg, Donald A. Statland, Robert D. Zimelis, Randall G. Dick, and Alan F. Segal, for the petitioners.

James F. Kidd and Janet A. Engel, for the respondent.


The Commissioner determined a deficiency of $46,043.74 in the petitioners' Federal income tax for 1972. The sole issue for decision is whether a limited partner in a " motion picture production service partnership" is entitled to deduct any part of the costs paid in 1972 for the production of motion pictures in that year.


Some of the facts have been stipulated, and those facts are so found.

The petitioners, Paul L. E. Helliwell and Marjorie M. Helliwell, husband and wife, resided in Coral Gables, Fla., at the time they filed their petition in this case. Mr. and Mrs. Helliwell filed their joint Federal income tax return for 1972 with the Internal Revenue Service. On December 24, 1976, after such petition was filed, Mr. Helliwell died. Subsequently, the Estate of Paul L. E. Helliwell, deceased, Mary Jane Melrose and Security Trust Co., personal representatives, was substituted as a party-petitioner.

On July 1, 1971, Champion Production Co. (Champion) was organized as an Illinois general partnership. Champion's partners were Burton W. Kanter, an attorney, Jerry Weiss, an accountant, and International Cinema, Inc. Champion's stated purpose was to provide production services required for the making of motion pictures. However, Champion did not maintain a production staff. The manner in which Champion proposed to conduct its business was set forth in a letter to the Commissioner, dated July 23, 1971, in which Champion requested a ruling that its use of the cash method of accounting for income tax purposes would be proper and that it could currently deduct the expenses of producing a motion picture. Attached to such ruling request was a proposed production agreement, which, in part, described the services to be performed by Champion:

Contractor [Champion] shall perform all functions necessary to prepare a negative of the Picture based upon the story and photoplay entitled " Chico." Such functions as are to be performed by Contractor hereunder shall include

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but shall not be limited to providing the following services: contracting for actors and actresses, doing layout and direction, photography, sound, wardrobe, props and set dressing, background, editing and music, provided, however, that Owner has acquired the aforementioned Total Picture and shall make the same available to Contractor at no cost to Contractor to the extent necessary for Contractor to perform its functions hereunder. It is the intent of the parties that upon completion of Contractor's obligations hereunder, the Picture will be complete and a negative ready for development of prints preparatory for distribution by Owner.

In the motion picture industry, a service company supplies the technical services that independent producers need to make a film, either because such producers lack technical expertise or because they cannot afford to keep a technical staff on a permanent basis.

On December 17, 1971, in response to such ruling request, the Commissioner ruled that Champion could adopt the cash method of accounting, that such method would be considered to clearly reflect income within the meaning of section 1.446-1(a)(2) of the Income Tax Regulations, and that any amounts which were properly deductible under section 162 of the Internal Revenue Code of 1954[1] could be deducted in the year such items were paid. Such ruling provided, in part, that:

According to the information submitted, Champion is a partnership engaged in the business of performing various functions required for the production of a motion picture. Champion contracts with the owners of the rights to produce a motion picture to perform such services as hiring some of the actors, directing the film, photographing the production, editing the film, and handling the financial and budget aspects of making a film. For its services Champion receives a fixed fee payable at various periods during and possibly after the completion of the production of the film. The payment of this fee is not contingent on the success of the completed film. Neither Champion nor any of its partners will own any interest either directly or indirectly in either the rights to make a film or in the completed negative by reason of the services performed by them in producing the film (other than any lien or other interest which may accrue through failure of the owners to make the required payment under the contract). It is also represented that neither Champion nor any of its partners will undertake the production of a film with an intention to acquire an interest in the completed negative.

It is indicated that the primary manner in which Champion will generate its income is through providing a wide range of professional services needed for the development of a negative film ready for duplication of prints. It is

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also indicated that the primary costs or expenses of generating Champion's income will consist of salaries and wages, interest on loans, editing services and professional fees for services. Thus there will be no substantial investment in physical plant, machinery or other equipment.

Subsequent to the issuance of the December 17, 1971, ruling, Champion abandoned its initial film services project and, through Mr. Kanter, entered into negotiations with John Heyman, a director of World Film Services Ltd. (WFS), a United Kingdom corporation, for the production of four films.

WFS was an established company with a known reputation in the film industry. It was engaged principally in the packaging, developing, and production of motion pictures and primarily derived its revenues from the services it performed. Since 1966, it had produced several successful films including " The Go-Between." The usual manner in which WFS produced films was to obtain a completed script or to acquire a " property" from which it developed a script. It then engaged a production manager who hired the film crew and arranged for the " bricks-and-mortar" aspects of making the film. WFS did not employ technicians on a permanent basis and did not own any equipment needed to produce films. In 1972, WFS was not in a sound financial position--its current liabilities exceeded its current assets. WFS's directors included John Heyman (chairman), Terence Baker, Edward Oldman, Norman Priggen, and Henry Thomas, who was also a lawyer for WFS.

At the time Mr. Kanter was negotiating with WFS, Mr. Heyman was also negotiating with Columbia Pictures (Columbia), Warner Bros., Paramount Pictures Corp. (Paramount), Twentieth Century-Fox Film Corp., Arrow Film, and several television networks concerning the production and distribution of the four contemplated films. One of such films, " Black Gunn," was originally brought to WFS by World Arts Media Film Productions Associates U.K. (World Arts Media) through its controlling director, Robert Hartford Davis. Mr. Davis had previously written the story for " Black Gunn" and requested that WFS act as agent for World Arts Media in obtaining the financing and distribution of such film. WFS hired Franklin Coen to rewrite the screenplay for such film and discussed the film with Paramount and Columbia. Subsequently, in early 1972, Columbia made an offer regarding " Black Gunn." Originally, World Arts Media was to produce the film for WFS

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with WFS being responsible for the delivery of the film to Columbia. However, World Arts Media was not able to contribute any of its own funds toward the production of the film, and the preliminary agreement among WFS, Columbia, and World Arts Media did not provide sufficient financing to produce the " quality" of picture desired by WFS and World Arts Media. As a result, WFS entered into negotiations with Champion in order to provide such additional financing.

As a result of his negotiations with WFS, Mr. Kanter concluded that Champion should be reconstituted as a limited partnership. On February 23, 1972, Champion requested a supplemental ruling from the Commissioner; such request provided in part:

As a result of certain production and financing opportunities recently presented, Champion contemplates...

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