Cheng v. Commissioner, Docket No. 24207-82.
| Decision Date | 17 April 1986 |
| Docket Number | Docket No. 24207-82. |
| Citation | 51 TCM (CCH) 861,1986 TC Memo 153 |
| Parties | William P. Cheng v. Commissioner. |
| Court | U.S. Tax Court |
Eugene D. Silverman and William W. Holcomb, for the petitioner. John F. O'Brien, Willard J. Frank, and Robert B. Dugan, for the respondent.
In a notice of deficiency, dated July 16, 1982, respondent determined deficiencies in petitioner's Federal income tax of $8,297 for 1977 and $22,679 for 1978.
This case is before the Court on respondent's motion for partial summary judgment, and petitioner's cross-motion for partial summary judgment, each filed pursuant to Rule 121, Tax Court Rules of Practice and Procedure. The issue raised in both motions is whether petitioner may deduct claimed losses for the taxable years in issue to the extent they resulted from alleged advanced minimum royalty payments.
Petitioner resided in San Diego, California at the time the petition was filed in this case.
The pleadings, affidavits and exhibits attached thereto contain the facts used for the purpose of ruling on the motions. The facts and inferences to be drawn therefrom must be viewed in the light most favorable to the party opposing the motion. Jacklin v. Commissioner Dec. 39,278, 79 T.C. 340, 344 (1982).1
Imperial Finance NV is a corporation formed in Netherlands Antilles which operated in Grand Cayman in the British West Indies. In 1977 Imperial Finance acquired an option to lease the mineral and mining rights on certain land in South West Africa. For each of the years 1977 and 1978 these rights were divided into one thousand "working interests" which were sublet to investors in full or fractional units. According to the sublease agreement, each working interest entitled the investor to mine and remove diamonds in return for a minimum annual royalty payment. The 1977 sublease provided for a five-year term which could be automatically extended from year to year upon payment of the minimum annual royalty until all the diamonds have been mined. The 1978 sublease called for a four-year term with the same provisions for extension.
The 1977 sublease agreement2 contains the following provision with respect to the minimum annual royalty:
The provisions dealing with remedies and forfeiture state in pertinent part as follows:
In 1977 petitioner Cheng acquired a one-fifth fractional interest and paid $30,000 as an advance minimum royalty payment. He paid $6,000 directly and the remaining $24,000 was paid by the Bank of Nova Scotia, an independent financial institution pursuant to a nonrecourse obligation executed by petitioner. Petitioner did not elect to terminate his sublease at the end of the first year. Petitioner acquired an additional one-fifth fractional interest in 1978 and, therefore, paid $12,000 cash directly and paid the remaining $48,000 with funds provided by an independent financial institution. Petitioner continued to make annual payments through 1980 at which time he terminated his interest.
Each of the loans referred to above was evidenced by a promissory note and a lending agreement. The lending agreements for each year, although apparently executed by a different financial institution, were identical. They provided that the lender would, in addition to the 80 percent royalty paid in the first year, lend to the investor up to 80 percent of the royalty due in succeeding years to the extent that the diamonds recovered for the investor did not generate funds sufficient to cover the succeeding years' royalties and that the investor was not in default under the sublease. Interest was to accrue at the rate of ten percent per annum. The lending agreements provided that the principal of the loan was payable solely from the investor's share of proceeds of sales of diamonds. The promissory notes permitted certain penalties attributable to the contract miner to be applied to the interest on the notes. The notes stated that in the event any principal remained unpaid at the expiration of fifteen years from the date of the note, the remaining balance would be due and payable. The notes further stated in accordance with the lending agreement that the investor assigned to the lender as collateral all of the investor's rights under the investor's agreement with Imperial Finance, N.V. (the lessor), Universal Diamond Mining, N.V. (the contract miner) and Transworld Investors, Ltd. (the diamond sales company). Except for the aforementioned collateral, the lender was to be without recourse against the investor.
No diamonds were mined or sold in either 1977 or 1978.
Petitioner claimed on the Schedule C attached to his 1977 income...
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