Schneider v. Comm'r of Internal Revenue , Docket Nos. 8040-73— 8043-73

Citation65 T.C. 18
Decision Date09 October 1975
Docket NumberDocket Nos. 8040-73— 8043-73,8104-73.,8063-73
PartiesJUDITH SCHNEIDER, ET AL.,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
CourtUnited States Tax Court

OPINION TEXT STARTS HERE

Hilbert P. Zarky, for the petitioners.

Jonathan A. Brod, for the respondent.

Petitioners owned the stock of Raybert Productions, Inc. (Raybert), which, in turn, owned a motion picture named ‘Easy Rider’ and a television program known as ‘The Monkees.’ Raybert had a distribution contract entitling it to payments from Columbia Pictures Industries, Inc., based upon monthly accounting periods with respect to ‘Easy Rider,‘ and a similar contract with respect to ‘The Monkees' entitling it to annual payments on Nov. 30 from Screen Gems, Inc., for each fiscal year ending July 23. On May 23, 1970, Raybert was liquidated, and its assets were distributed to petitioners. Held, the ‘East Rider’ monthly payment for April 1970 is taxable to Raybert, and petitioners are liable as transferees for the tax thereon, but no part of the ‘East Rider’ payment for May 1970 or ‘The Monkees' annual payment is taxable to Raybert. Held, further, petitioners' taxable income for 1970, which included the gain on the liquidation distribution from Raybert, may not be adjusted for their liability as transferees of Raybert's assets. Held, further, petitioners are not entitled to recover their basis in the assets received on the liquidation of Raybert before recognizing any income therefrom.

FEATHERSTON, Judge:

Respondent determined the following deficiencies in petitioners' Federal income tax for 1970:

+----------------------+
                ¦Docket No.   ¦Amount  ¦
                +-------------+--------¦
                ¦             ¦        ¦
                +-------------+--------¦
                ¦8040-73      ¦$22,529 ¦
                +-------------+--------¦
                ¦8043-73      ¦17,787  ¦
                +-------------+--------¦
                ¦8063-73      ¦36,547  ¦
                +----------------------+
                

Respondent also determined a deficiency of $336,820 in the corporate income tax of Raybert Productions, Inc. (Raybert), a dissolved corporation, for the year ending June 30, 1970, and further determined that petitioners in docket Nos. 8041-73, 8042-73, and 8104-73 were liable under section 6901 2 as transferees of Raybert. Petitioners do not dispute their liabilities as transferees if the underlying income tax deficiencies are due, but they contest the determined deficiencies. The following issues are presented for decision:

(1) What part, if any, of certain payments received by petitioners under two contracts distributed to them as part of the liquidation distribution of Raybert is taxable to the liquidated corporation?

(2) If Raybert owes any income tax deficiencies for which petitioners are liable as transferees, whether petitioners are entitled to any adjustment in their individual tax liabilities for 1970, the year they received and were taxed upon the value of Raybert's assets distributed in liquidation?

(3) Whether petitioners, in their individual capacities, are required to report the income received by them under contracts distributed to them on Raybert's liquidation pursuant to the ‘income forecast method’ or are they entitled to recover their basis in the contracts prior to recognizing any of the payments as taxable ordinary income?

FINDINGS OF FACT
1. General

Petitioners were legal residents of Los Angeles, Calif., at the time their respective petitions were filed. They filed their Federal income tax returns for 1970 with the District Director of Internal Revenue, Los Angeles, Calif.

Raybert Productions, Inc. (hereinafter Raybert), was a corporation organized under the laws of the State of California on April 12, 1965. It had its principal place of business in Los Angeles, Calif. Raybert reported its income on the basis of a fiscal year ending June 30, employing the cash receipts and disbursements method of accounting. It filed its final corporate income tax return with the District Director of Internal Revenue, Los Angeles, Calif. One-half of Raybert's 30 outstanding shares was owned by petitioners Berton and Judith Schneider, as their community property, and one-half by petitioners Robert J. and Toby Carr Rafelson, as their community property.

2. ‘Easy Rider’

Prior to April 30, 1969, Raybert had acquired all rights in a feature-length motion picture entitled ‘Easy Rider.’ On that date, Raybert entered into an agreement with Columbia Pictures Industries, Inc. (hereinafter Columbia), whereby the latter was granted the right to rent, lease, license, exhibit, distribute, and otherwise dispose of the motion picture or any prints thereof for a period of 21 years. Columbia undertook to maximize the gross receipts from exploitation of the film and to utilize its best efforts consistent with sound business policy in that undertaking. All decisions relating to the distribution of the picture were left to the good business judgment of Columbia. The term of the agreement can be automatically extended in perpetuity unless and until certain purchase rights provided in the agreement are exercised.

The function of a distributor, such as Columbia, is to exploit the film in any manner that will maximize its economic return. Once the film is produced, the distributor decides how the film is to be marketed. This includes decisions as to the manner and extent of advertising as well as the scheme for the exhibition of the film.

The distributor, in the exercise of its discretion, decides upon the number and places of initial exhibitions as well as subsequent exhibitions. Agreements are then executed by the distributor with owners of theaters or chains of theaters, referred to as exhibitors. These agreements are often subject to change or renegotiation at a later date. Agreements with exhibitors vary but, as a general rule, the distributor receives a specified percentage of the box office receipts in exchange for granting the right to exhibit the film.

Once an exhibition plan is prepared and agreements concluded with exhibitors, prints of the film must be manufactured and delivered to the exhibitors. Color prints for an average motion picture cost approximately $650 per print. In addition, the film must be advertised. The extent of advertisement, choice of media, and other relevant decisions are left entirely to the distributor, and a method, once chosen, may be changed if the distributor so decides. Advertising and manufacturing of prints are the largest expenses involved in distributing a film.

As time passes, the film may be shelved for later reissue, either separately or double-billed with another film. In the event it is double-billed, the distributor must allocate expenses and receipts between the double-billed films.

Other decisions made by the distributor include those relating to syndication of the film for television viewing and production and distribution of foreign language editions of the film. With respect to the latter, decisions must be made whether to ‘dub’ the film or use subtitles. In addition, as in the case of domestic showings, decisions must be made with respect to advertising, shelving, reissuing, and adapting the film for television use.

In the instant case, Raybert's agreement with Columbia with respect to ‘Easy Rider’ provided that Columbia's gross receipts would be applied toward the payment of (a) trade association fees and (b) taxes. In addition, Columbia was to be paid its distribution fees, consisting generally of a charge of 30 percent of the balance of the gross receipts derived from licensing in the United States, 30 percent from Great Britain and Canada, and 37 1/2 percent from other countries; 10 percent from sales; and 25 percent from licensing for television showings. The remainder of the gross receipts is referred to as the ‘production share of gross receipts.’ From this remainder, Columbia was to recoup its print costs, advertising expenses, and other advances. After certain further adjustments were made, Columbia was to receive one-third and Raybert two-thirds of the remaining net proceeds. From its share Raybert was to pay the Pando Corp., from which it had acquired the film, one-third of the net proceeds. The agreement also contains provisions for handling foreign currency transactions.

Columbia agreed to furnish Raybert with monthly statements, accompanied by payments, for a period of 18 months after the release of the picture and thereafter semiannually. The statements were to show Columbia's receipts and billings within each distribution territory relating to the preceding month or semiannual period. In addition, the statements were to show the permitted deductions from gross receipts. These statements were to be submitted— within 45 days with respect to United States transactions and 120 days with respect to foreign transactions— after the close of the period for which each statement was made.

Raybert had a limited right to inspect Columbia's records, as they related to ‘Easy Rider,‘ for the purpose of checking the accuracy of the accounting statements. Exercise of this right had to be elected within 18 months after delivery of the statements in accordance with the following provision:

Nothing herein contained shall be deemed to give you the right to go into any matters or items which make up any of the items contained in any such statement, if inquiry into same shall require an examination of our records or books after the expiration of 18 (eighteen) months from and after the date of any statement questioned by your, it being the intention hereof that statements not questioned by you by notice in writing within said 18 (eighteen) month period shall be final and conclusive account stated. You shall be forever barred from maintaining or instituting any action or proceeding based upon, or involving, or in any wise relating to, or pertaining to, or concerning any transactions had by us, our affiliates or our or their licensees in connection with the Picture and the accounting embraced in any statement delivered hereunder or the...

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