Abramson v. Comm'r of Internal Revenue, Docket Nos. 4524-82

• Citation: 86 T.C. 360,86 T.C. No. 23
• Decision Date: 12 March 1986
• Docket Number: 5588-83,Docket Nos. 4524-82,16213-83.,5336-82,15578-83,5622-82,16624-82,16623-82,14479-83,15581-83,5854-83
• Parties: EDWIN D. AND SONDRA M. ABRAMSON, ET AL., Petitioners1 v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

86 T.C. 360

86 T.C. No. 23

EDWIN D. AND SONDRA M. ABRAMSON, ET AL., Petitioners1

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 4524-82

5336-82

5622-82

16623-82

16624-82

5588-83

5854-83

14479-83

15578-83

15581-83

16213-83.

United States Tax Court

Filed March 12, 1986.

HELD: Partnership's purchase and distribution of film was an activity engaged in for profit where the purchase price was determined through arm's-length negotiations and distribution efforts resulted in the expenditure of substantial sums of money. HELD FURTHER, limited partner's pro rata guarantee of partnership's nonrecourse obligation entitles limited partner to include pro rata portion of obligation in his partnership basis. HELD FURTHER, limited partner's pro rata guarantee of partnership's nonrecourse obligation entitles limited partner to include pro rata portion of obligation in his amount at risk. Pritchett v. Commissioner, 85 T.C. 580 (1985) distinguished. HELD FURTHER, partnership's depreciation deduction based on income forecast method is denied in absence of evidence supporting total forecasted income. Herbert L. Zuckerman, Robert J. Alter, and Felix C. Ziffer, for the petitioners.

Raymond J. Farrell and Albert Russo, for the respondent.

WHITAKER, JUDGE:

This consolidated case includes 10 different petitioners, one of which is a fiscal year corporation. Appendix A sets forth the petitioners by name and docket numbers, the tax years involved, the deficiencies for each year, the places of residence of each individual petitioner, and the principal place of business of the corporate petitioner when each petition was filed. Each of the petitions includes, among other issues, the common issue of the tax consequences of the investment by the individual general partner and by all of the limited partners in a New Jersey limited partnership known as Surhill Company (Surhill). In the statutory notice, respondent disallowed each partner's share of the partnership losses, which included current expense and depreciation deductions. Issues related to this matter were severed and consolidated for the purposes of trial, briefing, and opinion. The issues arise out of the acquisition in 1976 and the exploitation of a movie originally titled ‘Scandal‘ or ‘Scandello‘ and retitled ‘Submission‘ (Submission).

The issues as framed by respondent may be summarized as:

(1) Whether Surhill was organized with an intention to make a profit; and

(2) if issue (1) is decided in favor of petitioners,

(i) whether petitioners may include in basis the amount of a nonrecourse note evidencing the unpaid portion of the purchase price due the seller of Submission;

(ii) whether Surhill is entitled to an allowance for depreciation under the income forecast method for the tax year 1977;

(iii) whether the depreciation deductions claimed by Surhill for the years 1977 and 1978 were properly computed in accordance with the income forecast method; and

(iv) whether petitioners were at risk under section 465 ² for the amount of the nonnegotiable promissory note element in the purchase price by reason of a written guarantee (sometimes referred to as so-called guarantee) by the limited partners running to the seller of Submission. ³

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. At the time of filing of the petitions, the residences of the several petitioners were as set forth in Appendix A. To the extent material with respect to the years involving the severed issues, the petitioners filed timely income tax returns and respondent issued timely statutory notices. ⁴

Surhill was formed as a limited partnership under the laws of the State of New Jersey on December 10, 1976 by Edwin D. Abramson (Abramson). He and his wholly owned corporation, Creative Film Enterprises, Inc. (Creative), were the general partners of Surhill. The remaining petitioners were limited partners but not all of the limited partners have filed petitions with this Court with respect to the Surhill issue. Surhill was organized for the purpose of purchasing the United States' rights to Submission. Creative was incorporated under the laws of the State of New Jersey by Abramson for the purpose of locating movies for acquisition by limited partnerships similar to Surhill and to become a general partner in such limited partnerships. The general partners together contributed $3,333 to Surhill and are entitled to 1 percent of the sum of the profit or loss. The limited partners together contributed the sum of $330,000 and are entitled to 99 percent of the profit or loss. Surhill elected to use the accrual method of accounting and files its returns on the calendar-year basis.

Abramson is a certified public accountant with offices in West Orange, New Jersey. ⁵ He has specialized in doing accounting work for businesses in the entertainment field and for entertainers. For many years he has represented entertainers and authors in connection with film production and distribution matters, has assisted in the production of a film, and many years ago had himself worked as a professional musician. In connection with the matters involved, Abramson was assisted by his legal adviser Felix Ziffer (Ziffer) who is an attorney, practicing in New York City and specializing in ‘leisure time activities‘ which includes the motion picture industry. From time to time, Ziffer has represented several of the major film producers and distributors and many businesses and individuals in business matters pertaining to the production and distribution of films. On occasion he and Abramson have represented the same client in specific matters and Ziffer has also represented Abramson personally from time to time in motion picture matters. Ziffer, at some point in the past, also acquired and produced films for his own account.

Submission is a color, feature length (96 minutes) motion picture made in Europe in the English language and post-synchronized. ⁶ The principal actor Franco Nero in 1976 had played roles in other movies successfully distributed in the United States with some United States name recognition. The lead female Lisa Gastoni also had some recognition in this country. Submission is well photographed and directed and is of a quality quite acceptable to United States audiences. It has an MPAA rating of R. In content, Submission is similar to ‘Emanuelle‘ and ‘Story of O‘ which were X-rated films distributed shortly prior to 1976. Submission is also similar to the film ‘Swept Away‘ which also had a successful box office reception in the United States.

In early 1976, Submission was brought to the attention of Joseph Brenner (Brenner) the principal officer of Joseph Brenner Associates, Inc. (Associates), a small independent distribution company which had been in that business since 1954. From 1954 to the date of trial, Associates has acquired the distribution rights to 40 to 50 films. Brenner was interested in Submission and arranged to screen it with his son and other associates. Based on the screening, he concluded that the film would appeal to all types of audiences and would play in top theaters. In his judgment, it was of good quality, had superb acting, and excellent music. He negotiated with Walter Bedogni, an officer of Rizzoli Company, S.P.A., the owner of the film, which led to a proposal to contract with Associates for the distribution rights for an advance payment of $150,000 in cash plus a percentage of distributor film rentals. Negotiations ceased because the cash payment was more than Associates could afford to pay.

Thereafter, the film was presented to Abramson and Ziffer, with the information that Associates was interested in the distribution rights. At this time (the latter part of 1976), Abramson was looking for films to present to investors using the criteria that the film must be commercially feasible and viable and well produced with name actors. Prior to screening Submission, they had screened five to eight other films. The film was screened by Abramson and Ziffer twice during the month of November 1976. Negotiations went forward somewhat simultaneously with Bedogni with respect to the acquisition of the film and with Associates with respect to distribution of the film. One of the factors which influenced Abramson to negotiate for acquisition of the film was Brenner's excitement about its prospects and his (Brenner's) conclusion that Submission could generate several million dollars worth of distributor film rentals. Abramson and Ziffer were both aware of the substantial success of the films ‘Story of O,‘ ‘Emanuelle,‘ and ‘Swept Away‘ which films generated $3 to $6 million in film rentals. On that basis, Abramson estimated that his prospective investor group would do very well. During the course of negotiations with the seller's agent, Abramson and Ziffer were informed that ‘Submission,‘ under the name ‘Scandello‘ had been shown in foreign markets and generated approximately $340,000 of revenues. They were also informed that the production cost was approximately $2 million.

The initial asking price for Submission was $1 million in cash plus a percentage of film rentals. The agreed upon price for the right to exploit Submission in the United States was $1,750,000, payable $225,000 in cash and $1,525,000 evidenced by a nonnegotiable nonrecourse promissory note with interest. The note was due in 10 years, but was also payable out of one-half of the revenues received by Surhill from the film's distribution. As discussed below, payment of the purchase price was guaranteed by the partners. The deferral of a substantial portion of purchase price was valuable to Abramson's prospective investors.

Abramson and Ziffer also negotiated a distribution contract with Associates. The agreement required payment by Associates to Surhill of a percentage of net distributor film rentals, that is the excess of Associates' receipts over its expenses, but modified in that advertising expenses in one...