Vanderschraaf v. Commissioner
| Decision Date | 02 July 1997 |
| Docket Number | Docket No. 37087-86.,Docket No. 21729-88.,Docket No. 8910-88.,Docket No. 6079-88. |
| Citation | 74 T.C.M. 7 |
| Court | U.S. Tax Court |
| Parties | John C. Vanderschraaf and Cornelia Vanderschraaf, et al.<SMALL><SUP>1</SUP></SMALL> v. Commissioner. |
Michael J. Christianson, for the petitioners. Elizabeth Girafalco Chirich and Susan K. Greene, for the respondent.
Respondent determined deficiencies in petitioners' Federal income taxes, additions to tax, and increased interest, as follows:
Docket Nos. 37087-86 and 8910-88
John C. and Cornelia Vanderschraaf
Increased Interest and Additions to Tax
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Sec. Sec. Sec. Sec
Year Deficiency 6621(c) 6653(a) 6653(a)(1) 6653(a)(2) Sec. 6659 Sec. 6661
1980 ........ $23,084 * $1,154 -- -- -- --
1981 ........ 21,939 * -- $1,097 ** $6,582 --
1982 ........ 12,184 * -- 609 ** 3,655 ***
Docket No. 6079-88
Estate of Donald R. Lawrenz, Sr., Deceased, and Ella A. Lawrenz
Increased Interest and Additions to Tax
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Sec. Sec. Sec. Sec
Year Deficiency 6621(c) 6653(a) 6653(a)(1) 6653(a)(2) Sec. 6659
1980 .................... $137,835 * $6,892 -- -- --
1981 .................... 200,227 * -- $10,011 ** $60,068
Docket No. 21729-88
Estate of Donald R. Lawrenz Sr., Deceased
Increased Interest and
Addition to Tax
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Year Deficiency Sec. 6621(c) Sec. 6653(a)
1979 ....................................... $212,325 * $10,616
* 120 percent of interest accruing after Dec. 31, 1984, on portion of the underpayment attributable
to a tax-motivated transaction
** 50 percent of interest due on portion of underpayment attributable to negligence
*** 25 percent of underpayment due on portion attributable to substantial understatement of tax
Unless otherwise indicated, all section references are to the Internal Revenue Code, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After settlement of some issues, the primary issue for decision is whether the profit objective of certain partnership investments should be measured at the partnership level or at the individual partner level.
Many of the facts have been stipulated and are so found. The entire trial record and the testimony and exhibits admitted into evidence in our test case opinion in Krause v. Commissioner [Dec. 48,383], 99 T.C. 132, 133-167 (1992), affd. sub nom. Hildebrand v. Commissioner [94-2 USTC ¶ 50,305], 28 F.3d 1024 (10th Cir. 1994), have been stipulated as part of the trial record herein. Krause involved limited partnership investments that are closely related to the limited partnership investments at issue herein.
Background and other general facts as they were found in Krause that relate directly and indirectly to the partnership investments involved herein we, by this reference, incorporate as findings of fact in the instant cases.
Petitioners, John C. and Cornelia Vanderschraaf, resided in Fountain Valley, California, at the time they filed their petitions.
Petitioners, Donald R. and Ella A. Lawrenz, resided in Corona Del Mar, California, at the time they filed their petitions.
On their respective Federal income tax returns for the years in issue, petitioners claimed large losses and interest deductions relating to investments as limited partners in Boulder Oil and Gas Associates (Boulder), Technology Oil and Gas Associates 1979 (Tech-1979), and Winfield Oil and Gas Associates (Winfield). Respondent disallowed these claimed losses and interest deductions, and petitioners filed the instant cases contesting respondent's adjustments.
After a lengthy trial in the Krause test cases, we analyzed, primarily at the partnership level, the objective of the particular partnerships involved in Krause. We concluded that the partnerships did not have the requisite profit objective to support the losses claimed, and we sustained respondent's disallowance of the claimed losses relating to the taxpayers' investments in the partnerships. Also, on the ground that the underlying debt obligations did not constitute genuine debt, we sustained respondent's disallowance of the claimed interest deductions relating thereto, and we imposed an increased interest rate under section 6621(c).
We did not, however, in the Krause test case opinion sustain respondent's determinations under sections 6653(a)(1) and (2), 6659, and 6661 of additions to tax for negligence, for valuation overstatements, and for substantial understatements of tax.
As indicated, our findings and holdings in Krause v. Commissioner, supra, were affirmed by the U.S. Court of Appeals for the Tenth Circuit.
The license agreements entered into by Boulder, Tech-1979, and Winfield with Elektra are not materially different from the license agreements entered into by the partnerships involved in the Krause test cases.
Facts found and conclusions reached in Krause with regard specifically to lack of profit objective of the partnerships involved in Krause are incorporated herein by reference and apply to Boulder, Tech-1979, and Winfield.
Similar to our findings in Krause v. Commissioner, supra at 169, with regard to the partnerships involved therein, the stated consideration agreed to by Boulder, Tech-1979, and Winfield for the license of enhanced oil recovery (EOR) technology and for the lease of tar sands properties was excessive, bore no relation to the value of that which was acquired, did not conform to industry norms, and precluded any realistic opportunity for profit.
In the oil and gas industry, a portfolio of technology is not ordinarily licensed when it is not known whether the technology will even work on the property on which the technology is to be implemented. EOR technology is known to be site specific. For this reason, the acquisition of a portfolio of EOR technology for use on particular properties typically does not occur in the oil industry.
In the late 1970's and early 1980's, when the license agreements involved in these cases were entered into, the established license fee in the oil industry for the right to use EOR technology was a 2-3 percent running royalty based on incremental increased oil production, or on the income actually realized therefrom, that was attributable to the particular EOR technology being licensed. The fixed fees to be paid by Boulder, Tech-1979, and Winfield for the EOR technology licenses were not competitive in the oil industry and were contrary to industry norms.
It was not necessary for Boulder, Tech-1979, and Winfield to license these technologies. Of the technologies licensed — Carmel VaporTherm (Carmel), TEC, ElektraFlo, and SME Oil Drive — only the TEC and Carmel processes were developed to any significant extent, and the TEC and Carmel processes could have been licensed by the partnerships directly from the inventors thereof for running royalties based solely on income realized therefrom. Thus, it was not necessary for Boulder, Tech-1979, and Winfield to license the Carmel and TEC processes from Elektra and pay up-front fees for them.
In the oil exploration and production industry, it is ordinary to lease tar sands properties based on projections of reserves, not oil in place.
The multimillion dollar license fees and lease royalties that Boulder, Tech-1979, and Winfield agreed to pay were excessive, did not reflect arm's-length debt obligations, and are not to be recognized as legitimate obligations of the partnerships. The license fees and lease royalties to which Boulder, Tech-1979, and Winfield agreed, and the related debt obligations, do not constitute legitimate, genuine debt obligations and are to be disregarded.
On partnership information returns of Boulder, Tech-1979, and Winfield, petitioners were identified as partners, and on petitioners' respective individual Federal income tax returns for the years in issue, they reported their distributive share of the substantial claimed losses and credits relating to Boulder, Tech-1979, and Winfield. By claiming these flowthrough partnership losses, petitioners repeatedly represented to respondent the existence of these partnerships and petitioners' status as partners of the partnerships.
It was the general partners and the promoters of Boulder, Tech-1979, and Winfield, not the limited partners, who controlled the transactions and activities of the partnerships. Actions and intent of the general partners with regard to Boulder, Tech-1979, and Winfield, including the profit objective of the partnerships or lack thereof, are attributable to petitioners. See Utah Code Ann. secs. 48-1-9, — 11 to — 15, — 17, — 18; 48-2a-403 (1994).
It is well established that the issue under section 183 as to whether partnerships are engaged in activity with a profit objective is determined at the partnership level. Pasternak v. Commissioner [93-1 USTC ¶ 50,226], 990 F.2d 893, 900 (6th Cir. 1993), affg. Donahue v. Commissioner [Dec. 47,306(M)], T.C. Memo. 1991-181; Simon v. Commissioner [87-2 USTC ¶ 9554...
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