Wildman v. Comm'r of Internal Revenue

• Decision Date: 10 June 1982
• Docket Number: Docket No. 13665-80.
• Parties: MAX E. WILDMAN and JOYCE L. WILDMAN, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

78 T.C. 943

MAX E. WILDMAN and JOYCE L. WILDMAN, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 13665-80.

United States Tax Court

Filed June 10, 1982.

Petitioner was a limited partner in a partnership formed to acquire and distribute a movie. In 1975, the partnership purchased the movie, “Sea Wolf,” for $460,000 cash plus a nonrecourse note of $3,540,000 secured by the movie. The partnership also paid $20,000 to the general partners, $33,000 in legal fees, and $2,500 in promotional expenses. The movie was released in December 1975. Held, even though amounts were due in 1975 to the partnership from the movie's exhibition, no depreciation deduction is allowable in 1975 under the income forecast method since the partnership, a cash basis taxpayer, had received no income in 1975. Siegel v. Commissioner, 78 T.C. 659 (1982), followed. Held, further, the $3,540,000 nonrecourse note unreasonably exceeded the fair market value of the movie; thus, the partnership may not include the face amount of the note in its cost basis. Held, further, petitioners are not allowed to change from the income forecast method of depreciation to an accelerated method of depreciation without respondent's consent. Held, further, the purchase and exploitation of the movie was an activity engaged in for profit. Held, further, retroactive application of sec. 48(k)(4), I.R.C. 1954, which allows an investment tax credit only to the extent of “qualified United States production costs” is not unconstitutional. Held, further, payments made to the general partners, for legal fees, and for promotional expenses must be capitalized. Sheldon P. Migdal and Bruce C. Strohm, for the petitioners.

Anita N. Gottlieb and James F. Kidd, for the respondent.

FAY , Judge:

Respondent determined a deficiency of $77,381.90 in petitioners' 1975 Federal income tax. The issues are whether petitioner Max E. Wildman as a limited partner is entitled to (1) a deduction for a distributive share of losses claimed by the partnership and (2) a claimed investment tax credit arising from the partnership's purchase and distribution of a movie.¹

FINDINGS OF FACT

Some of the facts are stipulated and are found accordingly.

At the time they filed their petition, Max E. Wildman and Joyce L. Wildman resided at Lake Bluff, Ill.

Max E. Wildman (petitioner) is a lawyer who has been practicing in Chicago for about 35 years. In mid-November 1975, petitioner received a letter from a Chicago law firm (hereinafter the law firm) soliciting his investment in a limited partnership, the New London Co., to be formed for the purpose of acquiring the United States and Canadian distribution rights to a movie called “Sea Wolf.” On November 24, 1975, petitioner signed a subscription agreement and purchased 50 units of New London Co. for $50,000.

New London Co. (hereafter New London or the partnership) was formed on December 3, 1975, pursuant to the New York State Limited Partnership Act. The partnership consisted of 2 general partners and 24 limited partners. The limited partners made cash contributions totaling $665,000. The partnership agreement provided 98 percent of the profits and losses were to be allocated pro rata among the limited partners, and the remaining 2 percent was to be allocated in equal shares to the general partners. The articles of limited partnership provided the partnership was to continue until December 31, 1991, unless sooner terminated by certain acts. A certificate of limited partnership for New London was executed and filed on January 12, 1976.

On December 8, 1975, a purchase agreement was entered into between Trans Continental Films Anstalt (TCA), a Liechtenstein corporation, and New London whereby New London acquired all of TCA's rights in a defined territory to the feature-length motion picture entitled “Sea Wolf.”² New London acquired the right to distribute the movie in any form of media in the United States, its territories and possessions, and in English-speaking Canada. In exchange, New London agreed to pay $4 million payable as follows:

(a) $275,000 cash on or before December 20, 1975,

(b) $185,000 cash on or before February 1, 1976, and

(c) a $3,540,000 nonrecourse note.

The $3,540,000 nonrecourse note was due in 12 years, bore interest at 6 percent per annum, and was secured by the movie. The note was payable solely from proceeds actually received by New London from exploitation of the movie. The agreement provided:

(1) [New London] shall retain all net receipts³ until [New London] has received a sum equal to all sums that would be payable to [New London] by the distributor from the first $1,540,000 of Net Film Rentals if the film were distributed directly by the distributor without the use of sub-distributors.

(2) thereafter, thirty (30%) per cent of net receipts shall be retained by [[[New London] and Seventy (70%) per cent paid to [TCA] in reduction of the Note until the Note is paid in full * * *

Thus, New London made cash downpayments of $460,000 to TCA, was entitled to retain its share of the first $1,540,000 of net film rentals, and, thereafter, was required to share its own net receipts with TCA (70 percent to TCA, 30 percent to New London) until TCA received $3,540,000.

The partnership turned over the function of distributing the film to a distributor who undertook to arrange exhibitions and to advertise and promote the movie in return for a percentage of the gross film rentals. Sometime before the execution of the purchase agreement with TCA, New London entered into such a distribution agreement with Allied Artists Picture Corp. (AA). AA acquired the exclusive right to distribute the movie in all forms of media for a period of 15 years. Generally, AA had complete control over all phases of marketing and distribution. AA agreed to use its best efforts to release “Sea Wolf” theatrically in the United States for not less than two play dates in 1975. AA was to pay New London 50 percent of theatrical gross film rentals. Generally, television and other nontheatrical gross film rentals were to be divided equally after AA was reimbursed for expenses of such distribution.⁴

The film, “Sea Wolf,” is a technicolor feature-length film based on a novel written by Jack London, a world-renowned American novelist. “Sea Wolf,” which had been made into a movie on several previous occasions, was produced in Germany in 1974 by Michael-Arthur Films Productions (Michael-Arthur). It was directed by Wolfgang Staudte and starred Edward Meeks and Raimund Haymstorf, none of whom have any significant American reputation. The screenplay was written by Walter Ulbrich. The movie had originally been made into a 6-hour film to be shown in a series of six 1-hour versions on German television. The movie was shortened to a 11;2-hour version and dubbed in English for the North American market. Prior to December 1975, “Sea Wolf” had not been exhibited in the United States. A brief description of the movie follows:

The year is 1903. It's the seafaring world of Jack London. A ship passes through the coastal waters off San Francisco. Suddenly there is a collision. Panic spreads through passengers and crew as they scramble for the lifeboats.

Passenger Humphrey Van Wyden is not as fortunate as some, he can only find a floating piece of debris holding him from the murky depths of the sea as he clings to safety. Then a ship appears out of the mist. It is the Ghost, on its way to Japan to hunt seals.

Wolf Larson captains the Ghost and although seemingly an educated man, he scorns normal human frailties and has no ethics. As captain he is the ultimate power aboard ship and sets himself up as judge and jury.

Van Wyden is a man with some intelligence, yet he feels intimidated by the futility of opposing Larson as he witnesses punishment dealt to members of the crew fighting for their rights as human beings. What transpires could only be written in the harsh memoirs of men at sea.

Van Wyden and Larson duel on their interpretations of morality and Van Wyden yields on his own principles out of fear for his own life. Larson realizes he has the edge because he is in control and the ultimate decision on who lives or dies is in his hands.

As the Ghost continues its journey, conflicts materialize between captain and crew to the point of rebellion. Larson is almost killed, yet returns to his task of running the ship, while relentlessly pursuing his rule by fear. His inhuman qualities are sure to lead to his downfall.

Van Wyden escapes, is rescued by a passing ship and as a result of his experiences aboard the Ghost has become enamored of the sea. He hires his own ship and charts a course for the mystical island of his childhood dreams. As he steps ashore and begins to explore the shores he is overcome by an innate fear. He discovers the Ghost and all the inhuman forces surrounding his previous experience begin to fill his mind. He finds Larson and feels the intimidation once overpowering his sense of right and wrong. Larson is near death and makes one last desperate attempt to succeed in corrupting his quarry but fails.

Whereas New London acquired the right to distribute “Sea Wolf” in most of North America, Twentieth Century Fox (hereinafter Fox), a widely known international corporation, acquired directly from the German producer, Michael-Arthur, the world-wide distribution rights of the same movie excepting the United States, Canada, Germany, Austria, Switzerland, France, Belgium, and the Iron Curtain countries. In exchange, Fox guaranteed a minimum payment of $390,000 for its world-wide rights excluding the Far East. For the Far East rights, Fox did not guarantee any minimum payment. Fox was also obligated to pay the producer 30 percent to 50 percent of film rentals. As of May 30, 1981, Fox had received gross receipts relating to the exhibition of “Sea Wolf” of $308,987.⁵ Net receipts (gross receipts less taxes and expenses) were $282,268. Michael-Arthur's...