West v. Comm'r of Internal Revenue
| Decision Date | 15 January 1987 |
| Docket Number | 20550-84.,Docket Nos. 20549-84 |
| Parties | JOE H. AND LESSIE M. WEST, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
On their 1980 amended Federal income tax return, petitioners claimed a loss with respect to a purported investment in a motion picture. In fact, no investment was made by petitioners until December of 1981, and the motion picture was not produced until 1982.
HELD, petitioners did not invest in the motion picture with an actual and honest objective of making a profit and petitioners are not entitled to deductions for depreciation with respect to the motion picture. HELD FURTHER, petitioners are not entitled to a theft loss deduction under sec. 165, I.R.C. of 1954, with respect to the $11,400 cash invested. HELD FURTHER, additions to tax under sec. 6659 and sec. 6621(d), I.R.C. of 1954, are sustained. Dwight J. L. Epperson, for the petitioners.
R. Alan Lockyear and Richard W. Kennedy, for the respondent.
In a statutory notice of deficiency dated April 5, 1984, respondent determined deficiencies in petitioners' Federal income tax liabilities and additions to tax as follows:
+-----------------------------------+
¦ ¦ ¦Additions to tax¦
+-----+------------+----------------¦
¦Years¦Deficiencies¦sec. 6659 ¦
+-----+------------+----------------¦
¦1977 ¦$3,591 ¦--- ¦
+-----+------------+----------------¦
¦1978 ¦1,822 ¦--- ¦
+-----+------------+----------------¦
¦1979 ¦5,823 ¦--- ¦
+-----+------------+----------------¦
¦1981 ¦9,642 ¦$2,893 ¦
+-----+------------+----------------¦
¦1982 ¦4,798 ¦1,439 ¦
+-----------------------------------+
After concessions, the issues for decision are: (1) Whether petitioners are entitled to deduct depreciation and to claim an investment tax credit with respect to the purchase of a single print of a motion picture: (2) whether, in the alternative, petitioners are entitled to deduct the out-of-pocket costs of the investment as a theft loss; and (3) whether petitioners are liable for the additions to tax under section 6659 1 set forth above. By way of written motion filed during trial of these consolidated cases, respondent also seeks the Court's determination as to whether petitioners are liable for the increased rate of interest for underpayments of tax attributable to tax motivated transactions under section 6621(d).
Some of the facts have been stipulated and are so found. Petitioners resided in West Valley, Utah, at the time they filed their petitions in these consolidated cases. The deficiencies and additions to tax at issue relate to an investment made by petitioner Joe H. West in a motion picture entitled ‘Bottom.‘ The motion picture was produced by Commedia Pictures, Inc. (‘Commedia ‘), a Utah corporation. During the years in issue, Commedia was engaged in the production, distribution, and sale of motion pictures. Commedia had its principal place of business in Salt Lake City, Utah.
In 1981, Commedia offered investments in a feature-length motion picture entitled ‘Bottom.‘ According to the prospectus associated with the investments, ‘Bottom‘ was to be a musical comedy about a Shakespearian actor named Nick Bottom who dies in a theater fire in 1605 and reappears as a ghost in Salt Lake City, Utah, some 375 years later.
The prospectus sets forth purported gross revenues received by various distributors from major motion pictures such as ‘Grease,‘ ‘Star Wars,‘ and ‘Jaws 2.‘ It provides some general information about the demand for the distribution of motion pictures, and briefly and generally describes the experience of the individuals acting in ‘Bottom.‘ The prospectus also briefly describes other motion pictures Commedia intended to produce, sets forth a sample of a projection of the profits that might be made from a motion picture (not specifically ‘Bottom‘), and a description of the different ways investments could be made in ‘Bottom.‘ The prospectus also provides a specific and detailed schedule of the tax benefits purportedly flowing from an investment in ‘Bottom,‘ and a legal opinion which specifically states that the opinion is not based on the attorney's independent verification of the facts with respect to which the opinion is rendered.
Conspicuously absent from the prospectus are any specific projections of the profit that might realistically be expected from the motion picture ‘Bottom.‘ Also absent from the prospectus is any helpful information about the actual success and experience of Commedia in producing and distributing motion pictures. All that is said about Commedia is the following:
Commedia Pictures Inc. is a Utah corporation engauged [sic] in the business of producing quality motion pictures, for both domestic and foreign television and theatrical release. Commedia maintains its home office at 1879 South Main Suite 104 Salt Lake City, Utah 84115 at 801-486-3453. Commedia is insuring the integrity and excellence of its product by a staff of outstandingly compentent [[[sic] craftsmen. The organization is based on absolute integrity and efficiency principles.
According to the prospectus, the protected cost of producing ‘Bottom‘ was ‘close to $1,000,000.‘ Also according to the prospectus, investments in the motion picture could be structured in two different ways. Under the fIRSirstructure, ownership of ‘Bottom‘ was divided into 100 units, each of which was to be sold to investors for $10,000 in cash. No debt or leverage was to be associated with such an investment. Commedia would have the right to and responsibility for distributing and marketing the movie and would be paid a distributor's fee for those services, which fee would be paid out of sales proceeds from the motion picture.
Under the second structure described in the prospectus for investing in ‘Bottom,‘ investors could purchase individual prints of ‘Bottom.‘ After acquiring ownership of a print, an investor would have the complete rights to and responsibility for marketing and distributing his individual print of ‘Bottom.‘ Commedia was not to be involved in the marketing and distribution of prints of ‘Bottom‘ owned by individual investors. Each investor who owned a print would be required to negotiate for the viewing of his particular print anywhere in the world.
Under this second method of investing in ‘Bottom,‘ the purchase price for an individual print of ‘Bottom‘ was stated in the prospectus to be ‘$18,000 with a 10 percent down payment and the balance due over a 10 year period.‘ Documents attached to the prospectus clarified that the purchase price for individual prints of ‘Bottom‘ actually was to be $180,000, to be paid by an $18,000 cash downpayment and a $162,000 recourse promissory note due in installments over 10 years. The prospectus also indicated, however, that during the last five years of the note, the investor's obligation thereunder could be converted by the investor to a nonrecourse obligation merely upon the payment of $1,000. The prospectus represented that a maximum of 30 prints of ‘Bottom‘ would be sold to individual investors and that the reason individual prints were being sold to individual investors was to raise funds ‘to meet production costs.‘
The record does not indicate that any investors purchased undivided interests in ‘Bottom‘ under the fIRSirsnvestment alternative described in the prospectus. Instead, apparently all 100 investors who purchased an interest in ‘Bottom‘ purchased individual prints thereof under the terms of the second investment alternative described in the prospectus.
Sometime in the early fall of 1981, petitioner Joe H. West 2 obtained a copy of the prospectus describing the investment opportunity in ‘Bottom.‘ On October 23, 1981, petitioner signed a Production Service Agreement in which he agreed to purchase a single print of ‘Bottom‘ for $180,000. The representative of Commedia, Frank Evans, and petitioner backdated the agreement to June 30, 1980. The agreement stated that the producer (Commedia) ‘shall deliver the print(s) to owner on or before December 10, 1980.‘
At the same time petitioner signed the Production Service Agreement, he also signed a promissory note to Commedia for $162,000. The note also was backdated to June 10, 1980, and expressly stated that it was a recourse liability. No payments of principal were due on the note during the initial five year term thereof except out of proceeds from the distribution of the individual print. Minimum payments of $5,000 were due each January 10 of the initial five years of the note with the first payment due on January 10, 1983. This annual $5,000 payment was due regardless of the availability of proceeds from distribution of the film and was to be applied only to interest which accrued at approximately 10 percent per annum.
At the end of the initial five-year term of the promissory note, the entire principal and accrued interest became due and payable. Petitioner, however, had the option to extend the note for another five years during which, according to the prospectus, the note could be converted to a nonrecourse obligation of petitioner by the payment of $1,000.
On or about October 19, 1981, petitioner received an undated form letter from Commedia Pictures containing the following statement concerning the ‘recourse‘ nature of the promissory note petitioner had signed:
THIS letter is to inform you and to carify [sic] our position on the following points; To the maker of a certain note conserning [sic] the financing of the said prints or print numbered herein above, and executed by the print holder or owner above, we hereby make the following representations that may be relied upon. 1. THAT THE MAKER OF THE SAID NOTE SHALL NOT BE RESPONSIBLE FOR ANY PAYMENTS WHATSOEVER AS TO THE PRINCIPAL OR INTEREST ARISING OUT OF THE SAID NOTE EXCEPTING THEREFROM THE...
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