Brannen v. C.I.R.

• Decision Date: 09 January 1984
• Docket Number: No. 82-8541,82-8541
• Citation: 722 F.2d 695
• Parties: 84-1 USTC P 9144 E.A. BRANNEN and Frances K. Brannen, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 695

722 F.2d 695

84-1 USTC P 9144

E.A. BRANNEN and Frances K. Brannen, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 82-8541.

United States Court of Appeals, Eleventh Circuit.

Jan. 9, 1984.

John E. James, J. Thomas Durden, Macon, Ga., for petitioners-appellants.

Glen L. Archer, Jr., Asst. Atty. Gen., Tax Div., Michael L. Paup, Chief, Appellate Section, Gilbert S. Rothenberg, Ann Belanger Durney, U.S. Dept. of Justice, Washington, D.C., for respondent-appellee.

Appeal from the Decision of the United States Tax Court.

Before VANCE and CLARK, Circuit Judges, and TUTTLE, Senior Circuit Judge.

TUTTLE, Senior Circuit Judge:

Frances K. and E.A. Brannen, husband and wife, appeal from a decision of the United States Tax Court determining a deficiency in their joint federal income tax in the amount of $6,984.09 for the calendar year 1975. The opinion of the tax court is reported at 78 T.C. 471. We affirm.

I. FACTS

Dr. E.A. Brannen ("taxpayer") ¹ is a medical doctor by profession. In late February or early March 1974, the taxpayer attended a movie investment presentation at the home of a close friend. At the meeting, Dr. W.L. Ryder, a psychiatrist who represented himself as an investment counselor, gave a presentation regarding the purchase of partnership interests in a New York limited partnership named Britton Properties. Ryder explained that the limited partnership was being formed to purchase a movie called "Beyond the Law." He presented the financial and tax aspects of the investment, and distributed a number of documents, including a law firm's opinion letter. The opinion letter stated, among other things, that the partnership would be respected for federal income tax purposes, that each limited partner's adjusted basis in the partnership would include his share of the nonrecourse partnership liabilities since the debt was a bona fide obligation, and that the seller of the film, Cinema Shares International, Ltd. ("CSIL"), was not related to the general partner or any of the limited partners of the partnership. A statement from Sancrosiap, S.p.A. ("Sancrosiap"), the producer of the movie, was also distributed at the presentation. This document listed the official production costs for the movie as approximately $1,450,000. A certificate from the president of Pictures & Movies Establishment ("P & M"), the seller of the movie to CSIL, stated that the gross earnings of the movie in American dollars was $2,700,000 in Italy and $4,000,000 in the rest of the world, excluding the United States and Canada. At the meeting, Ryder stated that usually the films that are well received abroad are better received in the United States, since it is a larger movie market.

The biographies of Michael Stern, who was to be the general partner of the partnership, Robert M. Fink, author of the tax opinion letter, and Lewis S. Ginsburg, who was the president of Stellar IV Film Corporation, which was the distributor of the movie, were distributed. A circular describing Britton Properties and listing financial projections assuming various stated gross proceeds was also distributed. The circular stated that the purchase price was to consist of a $400,000 capital contribution together with a $1,400,000 nonrecourse nonnegotiable promissory note bearing an interest rate of four percent. In addition, the taxpayer received publicity material including a number of still photographs from the movie and a one-page summary of the plot. The potential investors did not view the movie at the presentation. Aside from the limited partnership agreement which was presented, no other documents were presented at the investment presentation. No written appraisal of the film was circulated or discussed. The success and failures of Michael Stern were not discussed.

The maximum permissible depreciation was discussed at the presentation and the taxpayer noted on one of the documents distributed at the meeting that of the total amount of permissible depreciation, 96 percent would be deductible in the first two years of ownership--85 percent in the first year, and 11 percent in the second year. The taxpayer made this notation on a letter from Eli J. Warach, who was a vice president--managing editor of Prentice-Hall, Inc. The letter, which was dated January 29, 1974, stated that it was the author's conclusion that Britton Properties was "based upon sound and realistic economic practices and principles" and that "this program is built upon a solid economic and tax foundation."

At the meeting, Ryder advised the taxpayer that as a result of his initial $20,000 investment, he would realize tax savings of $43,530 during the first three years. If the $43,530 in tax savings were invested in five-percent tax exempt bonds, the total yield over the next nine years would be $31,900. At the end of twelve years, assuming that the picture was unsuccessful, each investor would be subject to recapture of $33,200 when the $1,400,000 nonrecourse note became due. After netting this recapture tax with the tax exempt income, the taxpayer was advised that he would make $22,000 on his investment of $20,000.

On March 26, 1974, several weeks after the presentation, the taxpayer purchased a 4.95 percent interest in Britton Properties. He signed the amended Limited Partnership Agreement of Britton Properties, which was dated as of January 15, 1974. The agreement stated that the partnership was formed to acquire the United States and Canadian rights to "Beyond the Law" and to distribute the movie by entering into a distribution agreement with Cinema Shares International Distribution Corp. ("CSID"). The agreement stated that the general partner was to manage the partnership business and was to be "the sole representative of the Partnership in all transactions with the third parties...."

In an agreement dated "April ____, 1974," Stern, as general partner of Britton Properties, entered into a purchase agreement for the movie with CSIL. CSIL was represented by its president, Richard Friedberg. Pursuant to the purchase agreement, Britton Properties purchased the movie "Beyond the Law" for the territory which included the United States and Canada, for the sum of $1,730,000 payable $200,000 on or before June 30, 1974, and $130,000 on or before December 31, 1974, such payments to be made in cash, plus the balance evidenced by a nonrecourse note for $1,400,000, together with interest at the rate of four percent per annum on the outstanding balance. The sole collateral for this nonrecourse note was the film itself.

Friedberg, as president of CSIL, had purchased the movie in 1973 from P & M for the sum of $1,491,250, of which $91,250 was to be paid in cash and the balance of $1,400,000 was evidenced by a non-negotiable nonrecourse promissory note which contained the exact terms as the note signed by Britton Properties. In a letter dated May 10, 1974, P & M stated that the cash portion of the purchase price of the movie was $75,000 so that the total purchase price was $1,475,000 rather than the $1,491,250 as originally agreed upon in the purchase agreement. Although Stern was an officer in CSIL at that time, he did not know the amount of the cash price paid for the film by CSIL. He was aware, however, of the amount of the note executed by CSIL because it was identical to the note the partnership subsequently executed when it purchased the film. Pursuant to a purchase agreement dated July 20, 1973, P & M had purchased the movie from Sancrosiap, the producer, for distribution in the United States and Canada for the sum of $50,000.

In May 1974, Britton Properties and CSID entered into a distribution agreement for the movie, whereby CSID was to receive a cash payment of $50,000, plus a percentage of the gross receipts. Pursuant to the agreement, CSID was obligated to expend $25,000 in the distribution and exploitation of the movie. CSIL had previously entered a distribution agreement with Stellar IV Film Corporation ("Stellar IV"), dated November 12, 1973, which stated that Stellar IV would act as the distributor for the movie until September 30, 1982. This agreement was similar to the agreement between Britton Properties and CSID except that it did not provide for the payment of any cash in advance of the distribution of the movie. In addition, Stellar IV was to expend not less than $50,000 for prints, advertising, and promotion. On July 5, 1974, Stellar IV and World Wide Film Distribution Corp. (World Wide) entered into an agreement whereby World Wide agreed to act as the subdistributor of Stellar IV's pictures.

In May 1974, Britton Properties and Omni Capital Corporation ("Omni") entered into a management agreement in which Britton Properties paid Omni $20,000 cash and Omni agreed to provide general and administrative services. The agreement was signed by Friedberg, as president of Omni.

The movie opened at the Red Raider Drive-In in Lubbock, Texas on July 10, 1974 and played through July 16, 1974. For the months of July through September 1974, the film played in Texas, South Carolina, and North Carolina. There were also twelve "combination showings" in Louisiana, South Carolina, North Carolina, and Mississippi during the period from August through early October. In a letter dated October 1, 1974, Stern stated that Stellar IV, the distributor of the movie, reported four bookings in October, three in November, and two in December. Two more bookings were reported in South Carolina in November and four in California in December. There was a total of fifty-four play dates for 1974 listed on various sheets of paper; however, there was no independent confirmation that the movie in fact played in all of these locations during the stated dates. There was a total of 160 play dates in 1975.

At some time in late 1974 after the poor opening of the film, Stern and Omni became concerned that Stellar IV was not properly distributing the film. They learned...