Pasternak v. C.I.R.
| Decision Date | 07 June 1993 |
| Docket Number | 92-1682,Nos. 92-1681,s. 92-1681 |
| Citation | 990 F.2d 893 |
| Parties | -1469, 93-1 USTC P 50,226 Frank C. PASTERNAK; Judith Pasternak (92-1681/1682); Anthony J. Cutaia; Diane Cutaia; David G. Koehlinger (92-1681), Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Frederick A. Patmon, Detroit, MI, Clarence B. Tucker, Sr. (argued and briefed), Detroit, MI, for petitioners-appellants.
Thomas J. Clark, Trial Attorney (argued), U.S. Dept. of Justice, Tax Div., Gary R. Allen, Acting Chief (briefed), Gilbert S. Rothenberg, U.S. Dept. of Justice, Appellate Section, Tax Div., Washington, DC, for respondent-appellee in No. 92-1681.
Thomas J. Clark, Trial Attorney (argued), U.S. Dept. of Justice, Tax Div., Abraham N.M. Shashy, Jr., Chief Counsel, I.R.S. Office of Chief Counsel, Gary R. Allen, Acting Chief (briefed), Gilbert S. Rothenberg, U.S. Dept. of Justice, Appellate Section, Tax Div., Washington, DC, for respondent-appellee in No. 92-1682.
Before: NELSON, Circuit Judge; and PECK and CONTIE, Senior Circuit Judges.
Petitioners-appellants, Frank C. Pasternak and Judith Pasternak; Anthony J. and Diane Cutaia; and David G. Koehlinger appeal a Tax Court decision upholding tax deficiencies and penalties against them for the taxable years 1981 and 1982 issued by the Commissioner of Internal Revenue, respondent-appellee.
Petitioners are persons who invested in various master recording leasing programs. Four corporations were set up by Misters Barbret, Labbadie, Rosanova, and the Detroit law firm of Patmon and Young ("the promoters"), which became the general managing partner of four limited partnerships. The promoters created three limited partnerships in late 1981 (Pop Phonomasters, Ltd., Soul Phonomasters, Ltd., New America Phonomasters, Ltd.) and one in 1982 (Rock Kandy Phonomasters, Ltd.). The alleged purpose of each limited partnership was to acquire and then lease to a group of investors the master recordings of an artist containing enough songs to constitute an album through entities designated as co-tenancies. It was then left up to the co-tenancies to process, press, distribute, and market the albums and other derivatives of the master recordings which had been leased. On December 28, 1981, the Pop, Soul, and New America Phonomasters limited partnerships each acquired master recordings of a designated artist with an initial purchase price of from $50,000-$10,000. Although the stated purchase price for the recordings, according to the purchase agreements, required the payment of additional fees of from $27,000 to $50,000 and of royalties, there is no evidence that the second fees and royalties were ever paid. For the Rock Kandy Phonomasters limited partnership, there is insufficient evidence that enough master recordings to constitute an album existed for it in 1982.
The promoters then formed four entities or "co-tenancies" named Pop Phonomasters Leasing, New America Phonomasters Leasing, Soul Phonomasters Leasing, and Rock Kandy Phonomasters Leasing for the purpose of leasing the master recordings to investors, such as the taxpayers herein. An investor joined one of the co-tenancies as a co-tenant by signing an acceptance to an offer to participate in the co-tenancy, an operating agreement, and a Phonomasters lease. Each co-tenancy leased the master recordings, which were to comprise an album of a designated artist, from either the Pop, Soul, New America, or Rock Kandy limited partnerships. About 45 investors invested in each co-tenancy. The leases granted the lessee-investors the exclusive right to exploit the recordings in the United States for a three-year-term and required a fixed rental payment and the payment of a fee to a marketing agent for a total of $275,000 (at least $435,000 for Rock Kandy). The lease for each co-tenancy stated that the "stipulated loss value" of the recordings were $3,370,000 ($6,144,400 for Rock Kandy), and that the co-tenancies, which bore the full risk of loss, were required to insure the recordings for at least that amount.
The co-tenants herein signed the acceptance of the offer and invested the following amounts to lease the master recordings from the respective Phonomasters limited partnerships.
1981 Cutaias New America $20,125
1981 Koehlinger Soul 5,000
1981 Pasternaks Pop 5,500
The co-tenants appointed petitioner Frank Pasternak as "co-tenancy operator" ("CTO") to manage the affairs of all four co-tenancies. He had the exclusive right and duty to conduct the affairs of each co-tenancy.
Pasternak, a CPA, knew little about the recorded music industry and had agreed to become co-tenancy operator at the request of Barbret and Labbadie, two of the promoters. He executed the leases, marketing agreements, and production and distribution contracts on behalf of the co-tenancies as he was instructed by the Phonomasters promoters without negotiating the terms of the agreements. He received none of the co-tenants' initial investments and kept no records of their interests.
The co-tenants' checks, payable to the various "leasing agents," 1 were deposited in the agents' accounts. Pasternak executed releases permitting the leasing agents to take their commissions from the funds received by the co-tenancies. The agents then deducted their commissions and paid the balance to a trust account at the law firm of Patmon and Young. Otherwise Pasternak did not know what happened to the investors' funds after they went to the leasing agents. He did not know how much of the co-tenants' money, if any, was ultimately used to pay for rent or for marketing of the master recordings.
Although the operating agreement signed by each investor-co-tenant specified that the CTO was obligated to keep records of co-tenancy activities, there is no evidence that Pasternak ever maintained any books or records, not even of the amounts invested by each co-tenant. Although he signed the marketing agreements with Opportunity Marketing, Inc., he made no payments to any marketing agents as required by the lease or knew whether any payments had ever been made. Opportunity Marketing was not paid $132,000 to market the master recordings of each artist as required by each lease agreement. Pasternak did not insure the master recordings for $3,370,000 as required by the lease ($6,144,400 for Rock Kandy).
When Pasternak sent investors, who had co-tenancy interests in 1981 and 1982 programs, notices of their "aliquot share" of the investment tax credit and business deductions resulting from the lease transactions, Pasternak had no knowledge as to whether the investors' funds had been paid over for eligible deductible business expenses rather than for capital expenditures or other nondeductible expenditures. The Phonomasters limited partnerships had elected to pass through the investment tax credits which they received from the purchase of the master recordings to the co-tenancies. 2 The amount of investment tax credit allocated among the co-tenants, with regard to the 1981 Pop, Soul, and New America leases, was based on the assumption that each artists' master recordings had a fair market value of $3,370,000. With regard to the 1982 Rock Kandy lease, the Pasternaks (the only persons in this appeal who invested in Rock Kandy) claimed an investment tax credit based on the assumption that the Rock Kandy recordings had a fair market value of $6,144,000. Thus, the tax returns filed by the respective petitioners for 1981 and 1982 were based upon the assumption that the Phonomasters limited partnerships' cost bases for the master recordings were as follows:
The Phonomasters limited partnerships had paid between $10,000 and $50,000 for the master recordings of each artist except for Bonnie Pointer, for whom all the master recordings that were to comprise an album never materialized.
On petitioners' tax returns, the amount of the business expense deductions equalled, for each taxpayer, exactly the amount invested by the taxpayer during the year in question. Pasternak testified that the information he provided to the co-tenants with regard to their proportionate shares of investment tax credits and business deductions was given to him by the Phonomasters promoters. Petitioners claimed investment tax credits and business expense deductions, pursuant to Internal Revenue Code Section 162, in the following amounts:
Section 162 Investment Amount
Year Taxpayer Deduction Tax Credit Invested
1981 Cutaias $20,125 $24,662 $20,125
1981 Koehlinger 5,000 6,127 5,000
1982 Pasternaks 6,660 6,114 6,660 The Commissioner disallowed the claimed deductions and credits arising from petitioners' investments in the Phonomasters leasing programs on the grounds that the transactions had no economic substance and were entered into solely to obtain the expected tax benefits. Accordingly, the Commissioner determined that petitioners were liable for various deficiencies and additions to tax.
Petitioners filed petitions for redetermination of these deficiencies and penalties with the Tax Court. Their cases were consolidated for trial before the Tax Court with cases of other investors in the Phonomasters leasing programs. 3
At trial, petitioners attempted to support the claimed values they used for investment tax credit purposes through the testimony of three purported experts, but the Tax Court rejected the arguments of these persons because they did not qualify as expert witnesses and their valuations had no basis for the estimate of the fair market value of the master recordings. The Tax Court accepted the testimony of the Commissioner's witness that the fair market value of each artists' master recordings ranged from $1,000-$20,000.
The Tax Court held that...
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