Cannon v. C.I.R.

Decision Date15 November 1991
Docket NumberNo. 90-9017,90-9017
Citation949 F.2d 345
Parties-5845, 91-2 USTC P 50,559 Charla Gates CANNON, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
CourtU.S. Court of Appeals — Tenth Circuit

Towner Leeper of Leeper & Leeper, El Paso, Tex. (Arthur Bosworth, Denver, Colo. with him on the brief), for petitioner-appellant.

Sally J. Schornstheimer of the U.S. Dept. of Justice, Tax Div., Washington, D.C. (Gary R. Allen, Richard Farber, and Shirley D. Peterson with her on the brief), for respondent-appellee.

Before MOORE and EBEL, Circuit Judges, and ANDERSON, District Judge *.

EBEL, Circuit Judge.

This case concerns a taxpayer who became involved in an unprofitable mining venture and deducted her distributive share of certain partnership losses on her income tax returns. The Commissioner of Internal Revenue disallowed these deductions, and the Tax Court upheld the Commissioner's determinations. The taxpayer appeals, raising two issues. First, did the Tax Court correctly resolve the case on a theory not considered by either party, namely, section 183 losses? Second, did the Tax Court correctly conclude that the limited partnership did not incur the expenses at issue with the requisite profit motive? We conclude that the Tax Court's reliance on section 183 was proper and that the court's findings regarding partnership motives were not clearly erroneous. Accordingly, we affirm.

I. BACKGROUND

The facts in this case are fully set forth in the Tax Court's opinion. See Cannon v. Commissioner, 59 T.C.M. (CCH) 164 (1990). For purposes of this appeal, they may be summarized as follows:

This case involves a taxpayer's treatment of losses incurred in connection with a Mexican gold and silver mining venture. In 1973, the taxpayer, Charla Cannon, joined a limited partnership ("Vemco") that was formed "to engage in the business of land development, exploration, mining and ore processing both in the United States and foreign countries." Id. at 165 (citation omitted). The taxpayer, who had a large annual income from trusts and her deceased husband's estate and employment benefits, provided Vemco with the funds necessary to conduct its business operations. In return, she was to receive a higher percentage than her partners of the profits or the proceeds in the event of a sale or disposition of the partnership assets. In addition, the annual expenses and losses of the partnership were allocated to the taxpayer insofar as her capital account permitted.

Vemco decided to invest in the Mexican venture at issue in this case in reliance upon the findings of an experienced miner who explored the sites and an engineer who analyzed and reported on the mining properties. Because Mexican law prohibits non-Mexican nationals or corporations from acquiring a majority interest in Mexican mining concessions, Compania Minera San Jose de Manzanillas, S.A. ("Manzanillas"), a Mexican corporation, held the mining concessions, and Vemco became a forty-nine percent shareholder in that corporation. 1 In 1978, however, Vemco discovered that the president of Manzanillas had been embezzling, and the mining concessions were transferred to Memco, a different Mexican corporation. Although the taxpayer, through Vemco, expended over $800,000 for exploration and development of the mines, Memco never operated at a profit. Vemco did not report any income from mining for the years involved in this lawsuit, nor did it receive any dividends.

The taxpayer deducted her distributive share of the partnership losses claimed by Vemco on her federal income tax returns for 1976, 1977, 1978, and 1979. The Commissioner of Internal Revenue ("Commissioner") disallowed these deductions on the grounds that the taxpayer did not establish that these amounts constituted ordinary and necessary business expenses or were for an activity entered into for profit or for the production of income. Alternatively, the Commissioner asserted that these amounts were nondeductible capital contributions to the Mexican corporation that the parties formed to hold title to the mines.

The Tax Court agreed with the Commissioner's decision to disallow the deductions, but found the expenditures to be nondeductible under section 183 of the Internal Revenue Code. Because the Tax Court decided the case on the basis of a section that neither party raised explicitly, the taxpayer filed a motion for reconsideration, which was denied. The taxpayer appeals. This court has jurisdiction to review the Tax Court's decision pursuant to 26 U.S.C. § 7482(a).

We first discuss whether the Tax Court erred in resolving this case on the basis of section 183. We then discuss whether the expenses at issue were incurred with the requisite profit motive.

II. DISCUSSION
A. The Propriety of Resolving the Case Under Section 183

In Commissioner v. Transport Manufacturing & Equipment Co., 478 F.2d 731, 735 (8th Cir.1973), the Eighth Circuit stated that the Commissioner should notify the taxpayer of the particular Code section, regulation, or theory involved in a case to avoid prejudice to the taxpayer. The court reasoned that "[t]he taxpayer works at an extreme disadvantage in trying to invalidate deficiency assessments if he does not specifically know why the Commissioner is challenging the taxpayer." Id. (footnote omitted). The court recognized, however, that prejudice does not always result: "Of course, if a certain Code section, regulation or theory has not been specifically raised in the notice of deficiency, in the pleadings, or at trial and if there is an absence of surprise on the taxpayer's part, the taxpayer has no reason to complain." Id. n. 8 (citation omitted).

Here, the taxpayer contends that the Tax Court erroneously decided this case on the basis of a theory and Code provision (lack of profit motive and section 183) that neither party considered or raised, thereby surprising and prejudicing the taxpayer. According to the taxpayer, only three Code sections were at issue: sections 162, 212, and 616. 2 We disagree. Section 183 is interrelated to sections 162 and 212, profit motive being the common underlying theme. Indeed, as discussed infra, these provisions even reference each other. Accordingly, we find that the taxpayer in this case was adequately put on notice, was not prejudiced, and should not have been surprised.

The taxpayer asserts that neither party ever considered the Tax Court's position that a profit motive was not present. Yet, the evidence reveals that profit motive was indeed a critical issue in this case and that the Commissioner was unwilling to concede the presence of a profit motive. For example, the statutory notices of deficiency that the Commissioner issued to the taxpayer expressly stated that she had not established that she entered into the transaction in pursuit of economic profit and that this lack of profit motive was one of the bases for the disallowance of the claimed partnership deductions. Record, vol. I, doc. 3, Deficiency Notice, Explanation of Adjustments, Exhibit A. In addition, the Commissioner's opening statement explicitly noted that the taxpayer had to prove a profit motive. Record, vol. II, Transcript, Nov. 19, 1986, at 26. Indeed, the taxpayer attempted to do this, see infra Part II.B, and acknowledged that "[t]o obtain a deduction under Section 162 for a trade or business expense or under Section 212 for an expenditure for the production of income requires a profit motive." Brief for Appellant at 37. 3

In determining whether the mining activity met the requirements of sections 162 or 212, the court naturally applied section 183. Section 183 is often used in analyzing "for profit" issues, both in the context of hobby losses and in the context of trade or business expenses. Numerous courts have used the regulations accompanying section 183 to determine profit motive under other sections. See, e.g., Independent Elec. Supply, Inc. v. Commissioner, 781 F.2d 724, 726-27 (9th Cir.1986) ("the courts have relied on the section 183 factors in conducting the profit motive analysis under section 162"); Brannen v. Commissioner, 722 F.2d 695, 704-06 (11th Cir.1984) (applying factors listed in section 183 regulations to determine whether taxpayer's activities were engaged in for profit under section 162); Faulconer v. Commissioner, 748 F.2d 890, 893 (4th Cir.1984) (referring to section 183 to determine whether a taxpayer was entitled to deductions under sections 162 or 212, noting that the profit motive is the same under all three statutory sections, and concluding that "[t]he regulations under section 183, therefore, explicate the profit-motive requirements of sections 162 and 212, and courts have properly relied on the section 183 factors in making the profit-motive analysis under sections 162 and 212"); Carter v. Commissioner, 645 F.2d 784, 786 (9th Cir.1981) ("[section] 183(c) must be read in conjunction with [section] 162") (footnote omitted); Dreicer v. Commissioner, 665 F.2d 1292, 1294 (D.C.Cir.1981) ("a taxpayer claiming a deduction under Sections 162 or 212 for an expense, or under Section 165 for a loss, must be prepared to demonstrate an associated profit motive in order to avoid the ban of Section 183") (footnote omitted). Thus, the Tax Court's application of section 183 was routine and predictable, not extraordinary.

In fact, the regulations accompanying section 212, on which the taxpayer relied, expressly refer to section 183. They specify that the inquiry as to profit motive under section 212 is determined by reference to section 183 and the accompanying regulations: "For provisions relating to activities not engaged in for profit applicable to taxable years beginning after December 31, 1969, see section 183 and the regulations thereunder." Treas.Reg. § 1.212-1(c). Section 183 similarly references sections 162 and 212 when it defines "activity not engaged in for profit" as ...

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