Estate of Baron v. Comm'r of Internal Revenue
| Decision Date | 26 September 1984 |
| Docket Number | Docket No. 14759-81. |
| Citation | 83 T.C. 542,83 T.C. No. 28 |
| Parties | ESTATE OF SYDNEY S. BARON, SYLVIA S. BARON, ADMINISTRATRIX, v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
B purchased certain rights in a master recording in exchange for $90,000 cash and $560,000 in two nonrecourse notes payable solely out of the record sales proceeds. B claimed depreciation deductions based on the $90,000 cash and a $460,000 nonrecourse note, the second note having been cancelled prior to the filing of the tax returns. HELD, the obligation represented by the nonrecourse note was too contingent to be included in basis irrespective of the existence of some value which might be considered fair market value. HELD FURTHER, petitioners have not carried their burden of proving that B had the requisite profit objective. THOMAS S. CARLES, RICHARD BARON, and ALICE M. CARLES, for the petitioners.
MARTHA SULLIVAN, for the respondent.
Respondent determined the following deficiencies in petitioners' Federal income tax for 1977 and 1978:
+--------------------+
¦Year ¦Deficiency ¦
+------+-------------¦
¦ ¦ ¦
+------+-------------¦
¦1977 ¦$230,031 ¦
+------+-------------¦
¦1978 ¦82,525 ¦
+--------------------+
After concessions, we must determine whether petitioners are entitled to various deductions and credits claimed in connection with Sydney Baron's purchase of the U.S. and Canadian rights in the master recording of the soundtrack of the motion picture ‘The Deep‘ (sometimes hereafter referred to as purchase of the master recording).
Some of the facts have been stipulated and are found accordingly.
Petitioners' legal address at the time the petition herein was filed was in Scarsdale, N.Y. Sydney S. Baron, (sometimes ‘Baron‘), petitioner Sylvia S. Baron's husband, died in 1981, prior to the filing of the petition.
In the spring of 1977, Richard Baron, Sydney Baron's son (and a tax lawyer), called Richard Talmadge (Talmadge), an entertainment lawyer, and asked Talmadge whether he knew of any good entertainment properties for Richard Baron's family to invest in.1 Talmadge then contacted Richard (Trugman), an old friend, who was vice chairman, secretary, and treasurer of Casablanca Record and Filmworks, Inc. (Casablanca). At first, Trugman told Talmadge that Casablanca had nothing to sell. In a subsequent conversation, Trugman told Talmadge that Casablanca would be willing to sell the United States and Canadian rights in the master recording of the soundtrack of ‘The Deep,‘ a movie they were working on at the time.2 Trugman briefly described the film and the record (who was involved, etc.) to Talmadge. Talmadge, in turn, relayed this information to Richard Baron. The master recording was of fine technical quality.
The original draft agreement between Baron and Casablanca, mailed by Talmadge to Richard Baron on May 12, 1977, called for a purchase price for the United States and Canadian rights in the master recording of $600,000, including a $500,000 nonrecourse note. The Barons insisted on the note being nonrecourse. Because Richard Baron was not well versed in commercial transactions, he asked Martin Engels (Engels), a good friend and a commercial lawyer with whom he shared office space, to help out on the deal. Richard Baron told Engels that instead of a cash fee, his father was prepared to give Engels a $100,000 nonrecourse note (at 6 percent interest), to be paid out of 10 percent of gross proceeds which Baron would be entitled to receive in respect of his rights in the master recording.
On May 18, 1977, Casablanca sold the United States and Canadian rights in the master recording3 to Whittier Development Corp., a shell corporation owned by Engels, for $550,000, payable $90,000 in cash and $460,000 by a non-recourse note (at 7-percent-per-annum interest), payable solely out of royalties from Casablanca's sale of records in respect of the master recording in the United States and Canada.4 The note was due on May 27, 1984 (seven years later). The $90,000 cash which Whittier used to purchase the rights in the master recording was received from Sydney Baron. At all times pertinent herein, it was understood by Casablanca, Whittier, and the Barons that Sydney Baron would be the ultimate purchaser of the rights in the master recording. Whittier was merely used as a middleman to provide Engels with a fee for his services. 6
On May 27, 1977, Whittier sold all of its rights and interest in the master recording to Sydney Baron for $650,000,7 payable $90,000 in cash (already advanced to Whittier for Casablanca), $460,000 by taking subject to Whittier's note to Casablanca, and $100,000 by Sydney Baron's nonrecourse note to Whittier. The $100,000 note was canceled by Whittier on March 1, 1978, at the request of Richard Baron, who represented to Engels that there was no further possibility of any distribution proceeds being generated. Up to that time, Engels had never attempted to collect on the note even though Sydney Baron was receiving royalties and even though Engels was entitled to 10 percent of Baron's gross royalties, i.e., without deduction for the share of the royalties which Casablanca was entitled to retain as payment on the $460,000 note.
Pursuant to a distribution agreement entered into between Casablanca and Sydney Baron, also on May 27, 1977, 8 Sydney Baron gave Casablanca the sole right to distribute ‘The Deep‘ soundtrack9 recordings in return for a royalty of 80 cents per LP album, including tapes, and 4 cents per 45 RPM single for records sold in the United States and a royalty of 40 cents and 2 cents, respectively, for albums and singles sold in Canada. Half of the royalties to be received by Sydney Baron were to be kept by Casablanca as partial payment of interest and principal on the $460,000 nonrecourse note.
The motion picture ‘The Deep‘ was based on a novel by Peter Benchley, the author of ‘Jaws.‘ The movie ‘Jaws‘ had been extremely successful and ‘The Deep‘ was perceived as the equally successful ‘Jaws‘ sequel. The ‘Jaws‘ soundtrack album was not nearly as successful as the movie; the album did not go ‘gold.‘ 10 Two independent organizations, Columbia Pictures Industries, Inc. (Columbia) and Casablanca,11 joined forces to produce the movie. Casablanca, at that time, was considered a young, successful, and aggressive record company;12 ‘The Deep‘ was the first motion picture production in which Casablanca participated. Making ‘The Deep‘ movie a success was of ‘major importance‘ to Casablanca.
Due to Casablanca's position in the record industry and its relationship to ‘The Deep‘ film, Casablanca wanted to produce the soundtrack album. Columbia finally decided to grant Casablanca rather than Arista Records, Columbia's subsidiary, that right. Several months before Casablanca officially received the right from Columbia to produce the soundtrack records, Casablanca was focusing on the expected album and its uses to promote the film. John Barry, the well-known arranger and composer of soundtracks for motion pictures and television specials, including ‘Born Free,‘ ‘Midnight Cowboy,‘ ‘The Lion in Winter,‘ and several James Bond movies, had already been selected by Columbia to arrange and compose the music for ‘The Deep‘ movie.13 In January 1977, Neil Bogart, Casablanca's president, estimated, in a memorandum to Trugman, that, with John Barry composing the album's music, ‘I don't believe we will sell less than 100,000 Lps, with a potential of 300,000.‘ Bogart also stated that ‘I'd feel comfortable if we can break even, and on 100,000 Lps, we'll come close * * * and help the movie.‘ Thus, the major purpose of the album was to promote the movie.
Casablanca soon began considering the possibility of having Donna Summer, one of their ‘stars‘ (see n. 12, supra) sing the title song in the film and on the soundtrack album. Casablanca's European licensees were very interested in such a soundtrack album, since Donna Summer had spent several years singing in Europe and was quite a sensation there. Casablanca projected that the album would sell better with Donna Summer on it. Columbia and John Barry agreed in April to have Donna Summer on the album recording. After the album was put together and the promotional activities planned, Casablanca hoped to sell, at a minimum, approximately half a million albums (i.e., go ‘gold‘).
Side 1 of the album recording contains an instrumental ‘ballet‘ by John Barry based on the score from the movie. On side 2, Donna Summer sings one song, ‘Theme From The Deep (Down, Deep Inside)‘14 twice, at different speeds. Side 2 also contains an instrumental version of ‘Theme From The Deep‘ by John Barry and a song ‘Disco Calypso‘ by an ‘obscure‘ group named ‘Beckett.‘
Casablanca vigorously sought to promote the movie and the album. Radio station contests with numerous prizes, including bikes, radios, cameras, Casablanca cassette libraries, and trips to Bermuda were held in over 50 cities.15 One hundred and fifty thousand copies of the album were pressed with blue, rather than black, vinyl (at an additional cost of 25 percent, or 15 cents per album) to make the album look like the ocean. A ‘The Deep‘ poster was included with each album (at a cost of approximately 10 cents per poster). Casablanca spent $250,000 to advertise the album, and thereby the movie as well, in the United States.16 Window streamers, posters, and dump boxes (which are used for placing a large number of records in one area of a store) were placed in record stores. Having missed out on the opportunity to get ‘Record of the Month‘ status for ‘The Deep‘ album (which would have resulted in distribution of the album through K-Mart department stores nationwide),17 Casablanca set up a deal whereby, for the first time, a contemporary album was sold nationwide through supermarkets. This promotion by Casablanca also had the effect of promoting...
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