Helba v. Comm'r of Internal Revenue, Docket Nos. 8218-83

• Decision Date: 30 October 1986
• Docket Number: 21648-84.,Docket Nos. 8218-83
• Parties: JAMES HELBA, JR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

87 T.C. 983

87 T.C. No. 63

JAMES HELBA, JR., Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 8218-83

21648-84.

United States Tax Court

Filed October 30, 1986.

Petitioner was the general partner in four partnerships which purchased videotaped productions. Each of the partnerships paid approximately $2,300,000 for a production. In each case, more than $2,000,000 of the purchase price was paid with a note guaranteed on a pro rata basis by the limited partners. The notes were initially fully recourse, but could convert to nonrecourse on the occurrence of certain contingencies. Each of the videotapes was purchased from a corporation which was either directly or indirectly controlled by Lawrence Scheer. Scheer effectively controlled all aspects of the transactions, while petitioner's primary activity involved obtaining investors for the partnerships. HELD, the purchase transactions here in issue were in substance shams lacking economic significance beyond expected tax benefits. Falsetti v. Commissioner, 85 T.C. 332 (1985).

HELD FURTHER, petitioner is liable for additional interest pursuant to section 6621(d) with respect to the amount of the underpayments attributable to basis claimed in the property in issue because such underpayments are attributable to tax motivated transactions. Sections 6621(d)(3)(A)(i), 6659(c), I.R.C. 1954. Kenneth M. Barish, Henry W. Walther, and John D. Humbert for the petitioner.

Marshall W. Taylor and Phoebe L. Tang, for the respondent.

NIMS, JUDGE:

Respondent determined the following deficiencies in petitioner's Federal income taxes:

+----------------+
                ¦Year¦Deficiency ¦
                +----+-----------¦
                ¦1979¦$40,701.00 ¦
                +----+-----------¦
                ¦1980¦54,942.12  ¦
                +----+-----------¦
                ¦1981¦35,482.90  ¦
                +----------------+
                

The issues for decision are:

1. Whether the transactions between the partnerships, executive producers and producers were tax shams lacking economic substance;

2. Whether the activities of the partnerships with respect to the purchase and distribution of the videotapes constitute activities engaged in for profit within the meaning of section 183;¹

3. Whether the partnerships may include in their basis in the videotapes the amounts represented by convertible notes;

4. Whether petitioner's basis in his partnership interests includes amounts attributable to services rendered or amounts paid with a promissory note;

5. Whether petitioner's amount at risk includes his pro rata portion of the partnerships' liabilities represented by the convertible notes;

6. Whether the partnerships used a proper method of depreciation for the videotapes;

7. Whether the partnerships are entitled to deduct organizational costs, management fees, legal fees, commissions and interest in the years in which they were incurred or paid;

8. Whether petitioner is entitled to claim investment tax credits with respect to the videotapes; and

9. Whether petitioner substantially underpaid tax in the years in issue as a result of a tax motivated transaction within the meaning of section 6621(d).

FINDINGS OF FACT

Some of the facts have.been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.

BACKGROUND

Petitioner resided in Pittsburgh, Pennsylvania, at the time the petitions were filed in this case.

Petitioner is a certified financial planner and was a general partner in each of the four limited partnerships which are the subject matter of this case. The four partnerships are Children's Fantasy, Limited (CFL), Geppetto's Music Shop (GMS), Merry Wives, Limited (MWL) and Macbeth, Limited (MBL) (collectively referred to as the ‘partnerships.‘)

Petitioner also held an interest as a limited partner in MWL. Each of the partnerships elected to use the accrual method of accounting.

As a certified financial planner, petitioner evaluated investment alternatives and advised clients on choosing investments. In the Fall of 1978, petitioner attended a four-day convention of the International Association of Financial Planners where, among other investment opportunities, firms were marketing videotape programs. Prior to this, petitioner had no knowledge or background in videotapes, movies, films, the home entertainment industry, or product distribution, other than being involved with the distribution of one film in 1976. Petitioner contacted only a few sellers of videotape investments, but he did receive a great deal of literature on such investments.

Knowing of petitioner's interest in videotape products, a colleague of petitioner's suggested that he contact Century Video Corporation (Century). Petitioner contacted Lawrence Scheer at Century in November, 1978. Scheer had formed Century in 1977, to act as an executive producer of television products. Scheer had first begun researching television production and the home video market in 1976. Prior to this, he had a 25-year career in the life insurance business. Leonard Francouer was the president and a director of Century.

Between 1977 and 1980, Century marketed single shows to individuals by use of an investment vehicle referred to as ‘one-on- ones.‘ Century contracted with Solaris International Pictures, Inc. (Solaris) to produce these shows. Century generally sold the one-on- ones to individual investors for a fixed price of $100,000, usually consisting of $10,000 cash and a promissory note in the amount of $90,000. Century would pay Solaris $6,000 to $7,000 in cash and execute a promissory note for $60,000 to $65,000 for the production. The notes executed by the investors were initially fully recourse with respect to the investors, but upon the occurrence of certain contingencies could convert to nonrecourse.

Solaris was a company through which Glenn Taylor produced television programs.² Through at least 1979, Glenn Taylor did not own any of Solaris' stock, but at some undetermined date he acquired an option on Solaris' stock by guaranteeing approximately $1,000,000 of the company's debt. He later gained control of Solaris by exercising this option. Glenn Taylor had previously produced television programs through a wholly-owned company, Syntar Productions (Syntar), but when Solaris was formed it took over the use of Syntar's production facilities. From 1975 to 1977, Syntar's productions were predominantly one-half hour shows which were financed by use of one-on-one investments. During 1976 and 1977, approximately 100 to 110 individuals purchased videotape productions from Syntar.

Prior to 1979, Century sold approximately 120 Solaris one-on- ones to 80 individuals. Starting in early 1979, petitioner recommended the purchase of videotapes marketed by Century to his financial planning clients. Approximately 20 of petitioner's clients invested in the one-on-ones, for which petitioner received client fees and sales commissions. None of these one-on-ones have returned any income to their individual investors.

PRODUCTION AND FINANCING STRUCTURE

In 1977, Scheer met with Jacob Brandzel, a tax partner in the accounting firm of Laventhol and Horwath, and Shelley Banoff, a tax attorney in the Chicago law firm of Katten, Muchin, Gitles, Zavis, Pearl & Galler, to discuss changes in the tax laws and development of a financing structure for producing videotapes based on a partnership format. The financing structure developed by Scheer, Brandzel and Banoff was used as the basis for the partnerships in this case. The plan required the partnerships to enter into a contract to purchase a videotaped production from an executive producer in exchange for cash and a note. Investor/limited partners contributed cash to the partnership and executed assumption agreements which made them personally liable for a pro rata portion of the note executed by the partnership. The liability of the limited partners pursuant to the assumption agreements, however, could terminate upon the occurrence of certain contingencies.

The executive producer was to acquire the videotaped production by entering into a production order subcontract with a producer. This contract would allow the executive producer to pay for the production by use of cash and deferred obligations. The producer, in turn, would hire talent to work on the production by paying them minimum cash payments and deferred obligations.

DEBT STRUCTURE

Banoff and Brandzel also developed the form of the notes executed by the partnerships and the assumption agreements executed by the investor/limited partners. The outstanding principal on each note, along with any accrued but unpaid interest, was due on February 1 of the eighth year following the year in which they were executed. The notes bore interest at an annual rate of nine percent, but interest in excess of $52,000 per year could be accrued and added to principal. The partnerships were required to use 80 percent of the gross receipts from distribution to pay principal and interest on the notes in each year.

The liability of the investor/limited partners under the assumption agreements could terminate, and the notes become nonrecourse, upon the occurrence of either of two contingencies. Their liability terminated if, at anytime during the term of the note, the partnership made payments on the note (interest and/or principal) totalling at least one-half of the principal amount of the note. If such payments were not made within 4 years following the execution of the note, however, the seller acquired exclusive rights to distribute video cassettes and video discs of the production. Thereafter, the liability of the limited partners would terminate if 4,000,000 (5,000,000 in the case of MBL) video disc and video cassette players had been sold in the United States, and $100,000 of gross distribution revenues were received after the end of the fourth year but before the maturity date of the note:

The principal amount of the note was determined by using the following method: (1) the approximate cash cost of the production was...