Cannon v. Commissioner
| Decision Date | 20 March 1990 |
| Docket Number | 2261-85.,Docket No. 9671-82 |
| Parties | Charla Gates Cannon v. Commissioner. |
| Court | U.S. Tax Court |
Towner Leeper, 661 Mesa Hills, El Paso, Tex., for the petitioner. Ana Guerrero and John F. Eiman, for the respondent.
Memorandum Findings of Fact and Opinion
In two separate notices of deficiency, respondent determined deficiencies in petitioner's income tax for the taxable years and in the amounts shown below:
Year Amount
1976 .............. $156,531
1977 .............. 245,576
1978 .............. 123,155
1979 .............. 106,628
Petitioner filed two petitions, one for the years 1976 and 1977 (docket No. 2671-84) and one for the years 1978 and 1979 (docket No. 2261-85). The issues in both dockets were similar so the cases were consolidated for trial, briefs, and opinion.
The parties filed stipulations of facts and the facts stipulated therein are so found.
After concessions by petitioner, the remaining basic issue is whether petitioner is entitled to deduct amounts of money she allegedly paid, through Vemco, a limited partnership in which she was a limited partner, in connection with a gold and silver mining venture in Durango, Mexico, during each of the years at issue. More specifically, the issues are:
(1) Whether the mining venture was an activity not engaged in for profit by and through Vemco within the meaning of section 183(a);2
(2) Whether the funds advanced to two Mexican corporations, by and through Vemco, were nondeductible shareholder contributions to the Mexican corporations or were deductible expenses of a joint venture between Vemco and the Mexican corporations;
(3) Whether amounts paid by Vemco to persons other than the Mexican corporations in connection with the exploration, development, and operations of the mining concessions constituted nondeductible capital contributions to the Mexican corporations;
(4) Whether the expenditures, if not capital contributions, were paid in connection with mining development (section 616) or mining exploration (section 617);
(5) Whether all of the aforementioned expenditures were ordinary and necessary;
(6) Whether petitioner has substantiated all of the amounts and the nature of the aforementioned expenditures; and
(7) Whether the application of section 482 reduces Vemco's (and petitioner's distributive share of) claimed inventory loss to zero for the taxable year 1976.
Petitioner, Charla Cannon, was a widow who lived in Denver, Colorado. She had a large annual income, primarily from various trusts established by her family, and from her deceased husband's estate, and various other benefits provided under bonus and pension plans by her deceased husband's former employer, Beatrice Foods Co. She had no education or experience in mining or engineering, except what she might have gleaned from her father, who was a mining engineer. She was 67 years of age at the time of trial in 1986. She received a junior college education at Bennington College in New York. She was engaged in several businesses prior to becoming involved in Vemco, including Cannon Aeronautical Center, raising sheep in Wyoming, a health spa for women, and selling helicopters in Colorado.
In 1973 petitioner became involved with a limited partnership, Vemco, in which she was a 54 percent limited partner. Vemco was a Texas limited partnership formed by Ramon Perez Madrid. The limited partnership was reconstructed under the same name in 1975. The limited partnership then consisted of Hersey W. Young, Jr. and Harold B. Young, general partners, and Charla G. Cannon, H. R. Chrisman, M.D., and Carl W. Weaver, limited partners.
The limited partnership agreement executed in 1975 set forth the purpose for Vemco which was "to engage in the business of land development, exploration, mining and ore processing both in the United States and foreign countries." This limited partnership agreement was amended again as of January 1, 1978. It recited that subsequent to the establishment of the partnership it needed additional funds to conduct its business operations, and Cannon had provided those funds; also that Cannon was willing to "provide further contributions to the partnership as requested by the general partner" provided the agreement was executed. It stated further that because of the agreement of Cannon to contribute additional capital to the partnership while the other partners were not contributing significant additional capital or services, it was agreed that the allocation of profits of the partnership, as well as the proceeds in the event of sale or disposition of the partnership assets, should be allocated as follows:
Name Percentage
Charla G. Cannon ............ 45%
Hersey W. Young, Jr. ........ 30%
H. R. Chrisman, M.D. ........ 9%
Carl W. Weaver .............. 8%
Harold B. Young ............. 8%
It was also agreed that the annual expenses and losses of the partnership would continue to be allocated to Cannon insofar as her capital account permitted. All of the expenses of the mining ventures, which were paid by petitioner through Vemco, were allocated to petitioner during the years here involved. Hersey W. Young, Jr. was designated to be the sole general partner with Harold Young, Cannon, Weaver, and Chrisman being limited partners. Harold B. Young resigned as a general partner.
In about 1970 Madrid acquired all the mining concessions for three mining claims, Ampl. de San Jose, San Jose, and Tres de Mayo, which were located in Sierra Madre Occidental Mountain range in the State of Durango, near the village of Manzanillas, in the Republic of Mexico. Madrid started working these claims prior to 1973.
The three San Jose mines were located in very mountainous country, near Durango, Mexico, at an elevation of 6,000 to 6,500 feet above sea level. The terrain is rough and the hillsides are very steep and roads are on a contour. Manzanillas is the nearest village. A very primitive road connecting Manzanillas and Topia, extending about 35 kilometers in length, was in place in 1973. The mines had been opened and worked by hand through shafts and tunnels. Gold and silver were found in veins extending underground.
Carl Weaver, an experienced miner and a limited partner in Vemco, entered into an agreement with Madrid in 1973 whereby Weaver paid Madrid $300 per month for the right to conduct exploration activities for a limited time at the site of the Madrid mining concessions. In return, Madrid obligated himself to transfer the mining concessions to a Mexican mining corporation at Weaver's request. After spending approximately 30 days at the mining site, Weaver prepared and submitted a report on the San Jose mining properties to Hersey Young, Vemco's general partner and a long time business associate of petitioner. In his report, Weaver estimated that the mine had been in operation since 1913 and that the ore in the mine (gold and other metals) was obvious, being exposed in the face of the mine. Weaver estimated that with proper development the mines had a potential production of 50 tons per day, although the small, very primitive mill on the property could not mill more than three tons in 24 hours. Weaver recommended the on-site installation of a larger capacity mill because the cost of freight to transport ore to the nearest smelter was about $100 per ton. Weaver also reported that the per ton ore values of various ore samples taken from the Taonita vein (located approximately one-half mile south of the San Jose mine) averaged between 0.7 and 1.0 ounces of gold and 9.0 ounces of silver.
Vemco's decision to invest in the mining concessions was based on Weaver's findings and on the findings of an engineer, Henry P. Ehrlinger (deceased at the time of the trial), whom Young retained to analyze and report on the mining properties. Ehrlinger was a professor of mining and engineering at the University of Texas at El Paso with much experience in mining activities in Mexico.
Ehrlinger visited the mine and subsequently sent Ralph Wilcox, Jr., then a graduate geology student at the University of Texas at El Paso, to the location of the mining claims. Wilcox prepared a report, dated April 1975, which included the assay results of the ore samples taken from the areas in which Manzanillas Corporation held mining concessions. In his discussion of Taonita, Wilcox revealed the following assay results of certain ore samples:
Ounces ofOunces ofDescriptionGold Per TonSilver Per Ton
Channel sample ......... 0.04 0.76
Channel sample ......... 0.28 6.04
Quartz vein ............ 0.04 0.60
The report also included a discussion of the Tres de Mayo mine and contained the following assay results of three channel samples taken at or near the mine:
Ounces of Ounces of
Description Gold Per Ton Silver Per Ton
N 1 Entrance, first level 0.34 3.16
N 2 Second level, rear .... 0.04 0.58
N 3 Third level, rear ..... 0.96 13.18
Wilcox's report also included the following comments regarding the mill located below Manzanillas:
Ehrlinger prepared a mining report, dated May 1975, which included Wilcox's findings. Ehrlinger's report contained profit projections based on 50 tons of ore mined daily and a respective gold and silver ore grade of 0.70 and 9.0 troy ounces per ton of ore mined. Total monthly expenses were projected at $99,011.68. Of these monthly expenses only one, income taxes of $18,117.68, varied with changes in profitability. All other expenses, fixed or variable, were unaffected by changes in the precious metal ore grade per ton of ore mined. Ehrlinger's report projected a monthly ore mining operating rate of 1,200 tons and a "net calculated monthly profit"...
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