The opinion
T.C. Memo. 2010-2
UNITED STATES TAX COURT
WALTER M. PRICE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
SANDRA K. PRICE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 9611-06, 9642-06. Filed January 4, 2010.
Trent D. Reinert and David S. Houghton, for petitioners.
Albert B. Kerkhove, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
THORNTON, Judge: The issue for decision in these
consolidated cases is whether gifts that petitioners made of
limited partnership interests to their adult children during
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2000, 2001, and 2002 qualify for annual exclusions as provided by
section 2503(b).1
FINDINGS OF FACT
The parties have stipulated some facts, which we incorporate
herein. When they petitioned the Court, petitioners resided in
Nebraska. They have been married for many years and have three
children, all of whom were of adult age at all times relevant to
these cases.
Formation of the Partnership
In 1958 Walter M. Price (Mr. Price) began his career in
equipment finance and distribution at Caterpillar Tractor Co. He
later worked for a dealer in Omaha, Nebraska. In 1976 he started
his own company, Diesel Power Equipment Co. (DPEC), which
eventually distributed and serviced about 40 lines of equipment
and had about 90 employees.
Petitioners’ children had no career interest in working for
DPEC. Consequently, when a group of long-term employees made an
offer in the late 1990s, petitioners decided to sell the business
as part of a careful financial plan which involved first placing
the DPEC stock in a limited partnership.
On September 11, 1997, petitioners formed Price Investments
Limited Partnership (the partnership) as a limited partnership
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue. Rule
references are to the Tax Court Rules of Practice and Procedure.
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under Nebraska law. When the partnership was formed, Price
Management Corp., a Nebraska corporation, was its 1-percent
general partner; the Walter M. Price Revocable Trust and the
Sandra K. Price Revocable Trust were each 49.5-percent limited
partners. Mr. Price was president of Price Management Corp., and
Mr. and Ms. Price, through revocable trusts, held the shares in
Price Management Corp.
When the partnership was formed, its assets consisted of the
DPEC stock and three parcels of commercial real estate leased
under long-term leases to DPEC and another equipment company. On
January 5, 1998, the partnership sold the DPEC stock and invested
the sale proceeds in marketable securities.
Gifts and Distributions to Petitioners’ Children
During 1997 through 2002 each petitioner gave each of their
three adult children interests in the partnership as shown below.2
2
The parties have stipulated that during each of the years
1998 through 2002, each petitioner made separate and equal gifts
to each child. The parties have also stipulated that during 1997
“petitioners” transferred a 17-percent partnership interest to
each child, without specifying the manner in which they made the
gifts. Because all the limited partnership interests were
initially held equally by petitioners’ respective revocable
trusts, and because all these limited partnership interests were
transferred to petitioners’ children by 2002, it would appear
that petitioners’ gifts in 1997 necessarily came equally from
petitioners’ respective revocable trusts. Although it makes no
difference to our analysis, for ease of presentation we have
assumed that petitioners made their 1997 gifts, like all the
other gifts, separately and equally. The record does not reveal,
for any year, the exact manner in which petitioners effected
gifts to their children of the limited partnership interests held
(continued...)
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Partnership
Gift Interests Total
Transferred by Each Partnership Children’s
Petitioner to Each Gift Interests Cumulative
Year Child Each Year Interests
1997 8.5% 51% 51%
1998 1 6 57
1999 0.5 3 60
2000 0.5 3 63
2001 0.85 5.1 68.1
2002 5.15 30.9 99
On Forms 1065, U.S. Return of Partnership Income, for
taxable years 1997 through 2002, the partnership reported income
from rental activities and losses, gains, and other income from
investment activities. Each year except 1997 and 2001 the
partnership made cash distributions in equal amounts to each
child, as shown in the table below.
Total Partnership
Distributions
Year to Children
1997 --
1998 $7,212
1999 343,800
2000 100,500
2001 --
2002 76,824
Provisions of the Limited Partnership Agreement
The limited partnership agreement (the partnership
agreement) states that the partnership’s primary purpose is to
achieve a reasonable rate of return on a long-term basis with
2
(...continued)
originally by the revocable trusts.
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respect to its investments.3 The partnership agreement generally
prevents any partner from withdrawing capital contributions. The
partnership agreement also restricts transfer and assignment of
partnership interests as follows:
11.1 Prohibition Against Transfer. Except as
hereinafter set forth, no partner shall sell, assign,
transfer, encumber or otherwise dispose of any interest
in the partnership without the written consent of all
partners; provided, however, a limited partner may sell
or otherwise transfer his or her partnership interest
to a general or limited partner, or to a trust held for
the benefit of a general or limited partner. * * *
11.2 Assignment. Any assignment made to anyone,
not already a partner, shall be effective only to give
the assignee the right to receive the share of profits
to which his assignor would otherwise be entitled,
shall not relieve the assignor from liability under any
agreement to make additional contributions to capital,
shall not relieve the assignor from liability under the
provisions of the partnership agreement, and shall not
give the assignee the right to become a substituted
limited partner. * * * The partnership shall continue
with the same basis and capital amount for the assignee
as was attributable to the former owner who assigned
the limited partnership interest. * * *
3
The partnership agreement provides:
2.1 Purposes. The partnership shall invest in,
acquire, own, sell, encumber, operate, dispose of, and
deal in and with investment grade real and personal
property. The partners intend to reinvest income, gain
and profits from the partnership’s investments to their
mutual advantage, as the general partner may determine,
subject to the provisions hereof, and hereby declare
that annual or periodic distributions to the partners
are secondary to the partnership’s primary purpose of
achieving a reasonable, compounded rate of return, on a
long-term basis, with respect to its investments.
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The partnership agreement further provides that in the event
of any voluntary or involuntary assignment of a partnership
interest, “the partnership and each of the remaining partners
shall have the option to purchase the partnership interest for
its fair market value” from the assignee. The partnership
agreement provides detailed rules for exercising the purchase
option and for determining the fair market value of the
partnership interest.4 The partnership agreement provides
generally that the partnership will terminate after 25 years but
may be dissolved sooner if there is written consent or
affirmative vote “by at least two-thirds (2/3) in interest of the
partners.”
Pursuant to the partnership agreement, partnership profits
are shared by the partners according to their proportional
partnership interests. Partnership profits are to be distributed
to the partners “in the discretion of the general partner except
as otherwise directed by a majority in interest of all of the
partners, both general and limited.” The partnership agreement
states that neither the partnership nor the general partner has
4
The partnership agreement provides that for this purpose
fair market value is to be determined on the basis of a majority
of three appraisers, one selected by the partner exercising the
option, one selected by the assignee of the partnership interest,
and the third selected by the other two appraisers. The
partnership agreement requires that any purchase option be
exercised within 180 days of any involuntary transfer but
provides no deadline for exercising a purchase option with
respect to a voluntary transfer.
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“any obligation” to distribute profits to enable the partners to
pay taxes on the partnership’s profits.
The partnership agreement provides that it is to be
governed, construed, and interpreted according to the law of the
State of Nebraska. The partnership agreement is binding upon
“all the parties hereto, their heirs, successors, assigns, and
legal representatives forever.”
Petitioners’ Gift Tax Reporting and Respondent’s Determinations
On their separate Forms 709, United States Gift (and
Generation-Skipping Transfer) Tax Return, for 2000, 2001, and
2002 each petitioner identically reported gifts, annual
exclusions, and taxable gifts as follows:
Reported Reported Total Reported
Value of Total Annual Taxable
Year Each Gift Gifts Exclusions Gifts
2000 $14,905 $44,715 $30,000 $14,715
2001 20,770 62,310 30,000 32,310
2002 118,405 355,215 33,000 322,315
For each year petitioners reported zero gift tax due after
applying unified credits.
Petitioners attached to their gift tax returns valuation
reports supporting the reported gift values. Each valuation
report indicates substantial discounts for lack of control and
lack of marketability of the transferred partnership interests,
stating: “Unless a partner owns or controls two-thirds of the
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partnership interests, his/her investment is illiquid until at
least the scheduled termination date.”
Respondent issued each petitioner a notice of gift value
determination for 2000 and separate notices of deficiency for
2001 and 2002. Each of these notices disallowed annual gift tax
exclusions for each transferred partnership interest for each
year on the ground that the gifts were of future interests in
property. Respondent determined that petitioners had these gift
tax deficiencies for 2001 and 2002:
Year Petitioner Deficiency
2001 Walter M. Price $21,763
2002 Walter M. Price 14,741
2001 Sandra K. Price 20,480
2002 Sandra K. Price 14,602
OPINION
The parties disagree as to whether petitioners’ gifts of
partnership interests to their children are properly
characterized as present interests so as to qualify for annual
gift tax exclusions under section 2503(b). Petitioners bear the
burden of proving that their gifts qualify for annual exclusions.5
See Rule 142(a); Hackl v. Commissioner, 118 T.C. 279, 294 (2002),
affd. 335 F.3d 664 (7th Cir. 2003); see also Stinson Estate v.
United States, 214 F.3d 846, 848 (7th Cir. 2000).
5
Petitioners do not claim and have not established that the
conditions of sec. 7491(a) have been met to shift the burden of
proof to respondent with regard to any factual issue.
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A. Legal Framework
Section 2501 generally imposes a tax on the transfer of
property by gift. Section 2503(b) provides an inflation-adjusted
annual exclusion of $10,000 per donee.6 The annual exclusion
applies to “other than gifts of future interests in property”.
Sec. 2503(b)(1).
The statute does not define the term “future interests”.
The regulations provide:
“Future interest” is a legal term, and includes
reversions, remainders, and other interests or estates,
whether vested or contingent, and whether or not
supported by a particular interest or estate, which are
limited to commence in use, possession, or enjoyment at
some future date or time. The term has no reference to
such contractual rights as exist in a bond, note
(though bearing no interest until maturity), or in a
policy of life insurance, the obligations of which are
to be discharged by payments in the future. But a
future interest or interests in such contractual
obligations may be created by the limitations contained
in a trust or other instrument of transfer used in
effecting a gift.
* * * An unrestricted right to the immediate use,
possession, or enjoyment of property or the income from
property (such as a life estate or term certain) is a
present interest in property. * * * [Sec. 25.2503-3(a) and
(b), Gift Tax Regs.]
An example in the regulations provides that where a trustee is
authorized in his discretion to withhold payments of income for
addition to trust corpus, the beneficiary’s right to receive the
6
For 2002, the first year for which there was an inflation
adjustment, the exclusion amount was $11,000. Rev. Proc.
2001-59, sec. 3.19, 2001-2 C.B. 623, 627.
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income payments is not a present interest and no exclusion is
allowed with respect to the transfer in trust. Sec. 25.2503-
3(c), Example (1), Gift Tax Regs. Caselaw is to similar effect.
See, e.g., French v. Commissioner, 138 F.2d 254 (8th Cir. 1943).
The Supreme Court has stated:
it is not enough to bring the exclusion into force that
the donee has vested rights. In addition he must have
the right presently to use, possess or enjoy the
property. These terms are not words of art, like “fee”
in the law of seizin * * * but connote the right to
substantial present economic benefit. The question is
of time, not when title vests, but when enjoyment
begins. Whatever puts the barrier of a substantial
period between the will of the beneficiary or donee now
to enjoy what has been given him and that enjoyment
makes the gift one of a future interest within the
meaning of the regulation. [Fondren v. Commissioner,
324 U.S. 18, 20-21 (1945).]
In Hackl v. Commissioner, supra, this Court held that gifts
of units in a limited liability company (LLC) were gifts of a
future interest that did not qualify for the annual exclusion.
The Court rejected the taxpayers’ argument that a gift that takes
the form of an outright transfer of an equity interest in a
business or property is necessarily a gift of a present interest.
Id. at 292. The Court held that to establish entitlement to an
annual exclusion under section 2503(b), a taxpayer must--
establish that the transfer in dispute conferred on the
donee an unrestricted and noncontingent right to the
immediate use, possession, or enjoyment (1) of property
or (2) of income from property, both of which
alternatives in turn demand that such immediate use,
possession, or enjoyment be of a nature that
substantial economic benefit is derived therefrom.
* * * [Id. at 293.]
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B. The Parties’ Contentions
Petitioners contend that their gifts of the partnership
interests are properly characterized as gifts of present
interests because the donees can freely transfer the interests to
one another or to the general partner, Price Management Corp.
Petitioners also contend that each donee has immediate rights to
partnership income and may freely assign income rights to third
persons. They suggest that Hackl v. Commissioner, supra, was
decided incorrectly and contend that it is, in any event,
distinguishable from the instant cases.
Relying on Hackl, respondent contends that the transferred
partnership interests represent future interests because the
partnership agreement effectively bars transfers to third parties
and does not require income distributions to the limited
partners.7
C. Analysis
We decline petitioners’ invitation to reconsider our holding
in Hackl. Furthermore, we disagree that Hackl is distinguishable
from the instant cases in ways that are helpful to petitioners.
As explained below, applying the methodology set forth in Hackl,
we conclude that petitioners have failed to show that their gifts
of interests in the partnership conferred upon the donees the
7
Respondent stipulates that the fair market values of the
gifts were correctly reported on petitioners’ gift tax returns.
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immediate use, possession, or enjoyment of either (1) the
transferred property or (2) the income therefrom.
1. Application to the Transferred Property
We agree with petitioners that the partnership agreement
must be examined to determine whether the donees obtained the
immediate use, possession, or enjoyment of the transferred
partnership interests. We disagree, however, that the
partnership agreement permits the donees presently to access any
substantial economic benefit from the transferred property.
It is undisputed that under the partnership agreement the
donees have no unilateral right to withdraw their capital
accounts. Furthermore, section 11.1 of the partnership agreement
expressly prohibits partners from selling, assigning, or
transferring their partnership interests to third parties or from
otherwise encumbering or disposing of their partnership interests
without the written consent of all partners. As stated with
respect to analogous circumstances in Hackl v. Commissioner, 118
T.C. at 297, transfers subject to the contingency of approval (by
the LLC manager in Hackl and by all partners in the instant
cases) “cannot support a present interest characterization, and
the possibility of making sales in violation thereof, to a
transferee who would then have no right to become a member or to
participate in the business, can hardly be seen as a sufficient
source of substantial economic benefit.”
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Moreover, because of the operation of section 11.2 of the
partnership agreement, it appears that the donees are not even
properly characterized as limited partners in the partnership.
Section 11.2 of the partnership agreement provides: “Any
assignment made to anyone, not already a partner, shall be
effective only to give the assignee the right to receive the
share of profits to which his assignor would otherwise be
entitled * * * and shall not give the assignee the right to
become a substituted limited partner.” (Emphasis added.)8 It must
be remembered that when the partnership was created, petitioners’
children were not partners--the only partners were the 1-percent
general partner, Price Management Corp., and two 49.5-percent
limited partners, the Walter M. Price Revocable Trust and the
Sandra K. Price Revocable Trust. The record does not reveal
exactly how petitioners effected assignments of limited
partnership interests from these trusts to their children. But
however it was done, because the children were not already
partners, pursuant to section 11.2 they did not become
substituted limited partners; rather, the gifts were effective
only to give each child a share of the profits to which the
8
Petitioners contend that section 11.2 of the partnership
agreement permits the donees to sell their shares of partnership
profits to any third party without approval of the other partners
or the partnership. We disagree. This provision merely
describes the effect of assignments and does not supersede the
immediately preceding section 11.1 of the partnership agreement
restricting a limited partner’s ability to sell or assign his or
her partnership interest.
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revocable trusts otherwise would have been entitled.
Consequently, the donees lack the ability “presently to access
any substantial economic or financial benefit that might be
represented by the ownership units.” Hackl v. Commissioner,
supra at 296.
But even if it were to be assumed, contrary to the foregoing
analysis, that the donees did somehow become substituted limited
partners, it would not affect our conclusion that contingencies
stand between the donees and their receipt of economic value for
the transferred partnership interests so as to negate finding
that the donees have the immediate use, possession, or enjoyment
of the transferred property. Pursuant to section 11.1 of the
partnership agreement, unless all partners consented the donees
could transfer their partnership interests only to another
partner or to a partner’s trust. In addition, any such purchase
would be subject to the option-to-purchase provisions of section
11.4 of the partnership agreement, which gives the partnership
itself or any of the other partners a right to purchase the
property according to a complicated valuation process but without
providing any time limit for exercising the purchase option with
respect to a voluntary transfer.
Petitioners suggest that if one donee purchased the
partnership interest of another donee, the purchaser would gain
an “unrestricted and noncontingent right to the immediate use,
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possession or enjoyment of the partnership interest”, for
instance, by being able unilaterally to cause the partnership’s
liquidation.9 As just discussed, we do not believe that the
donees were substituted limited partners in the partnership.
Consequently, we do not believe that the donees possessed
anything more than income rights to transfer to each other or
anyone else. More fundamentally, we reject any suggestion that a
present interest in a donee is properly founded on additional
rights that the donee or some other donee might later acquire.
Petitioners allude to the possibility of the donees’ selling
their partnership interests to the general partner. It must be
remembered, however, that the general partner is owned by
petitioners and that its president is Mr. Price, who engineered
the gifts of partnership interests to his children in the first
instance. If the possibility of a donor’s agreeing to buy back a
gift sufficed to establish a present interest in the donee,
little would remain of the present interest requirement and its
statutory purpose would be subverted if not entirely defeated.
Cf. Chanin v. United States, 183 Ct. Cl. 840, 850, 393 F.2d 972,
9
The premise seems incorrect. Section 10.3.1 of the
partnership agreement permits the partnership to be dissolved
with the consent of “at least two-thirds (2/3) in interest of the
partners.” The greatest partnership interest held by any partner
(though not until 2002) was a 33-percent interest. A donee who
purchased another donee’s 33-percent interest would have only a
66-percent interest, which would be insufficient to unilaterally
effect a dissolution under section 10.3.1, which requires consent
by “at least two-thirds (2/3) in interest of the partners.”
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977 (1968) (rejecting the proposition that an annual exclusion
should be allowed “in every case in which the donee received a
future interest in property, which was marketable, thus doing
violence to the well recognized statutory purpose”).
Petitioners contend that the donees enjoyed a present
interest in the transferred property because they were able to
use the Schedules K-1, Partner’s Share of Income, Credits,
Deductions, Etc., that the partnership issued to them each year
as evidence of their own personal assets, thereby enhancing their
“financial borrowing ability.” Apart from Mr. Price’s vague and
uncorroborated testimony, there is no evidence to support this
contention. In any event, whatever benefit the donees might be
thought to enjoy in this regard is at best highly contingent and
speculative and does not, we believe, constitute a source of
substantial economic benefit, particularly in the light of the
restrictions on alienation (including on the ability of a partner
to “encumber” a partnership interest) contained in the
partnership agreement. Cf. Stinson Estate v. United States, 214
F.3d at 848 (holding that a gift of forgiveness of corporate
indebtedness was a future interest notwithstanding that the
individual donees saw an increase in their stock value due to a
balance sheet improvement of the debtor family-owned
corporation).
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2. Application to Income From the Transferred Property
In order to show that the gifts of the partnership interests
afforded the donees the right to immediately use, possess, or
enjoy the income therefrom, petitioners must show that: (1) The
partnership would generate income at or near the time of the
gifts; (2) some portion of that income would flow steadily to the
donees; and (3) the portion of income flowing to the donees can
be readily ascertained. See Hackl v. Commissioner, 118 T.C. at
298.
Because the partnership owned real properties generating
rents under long-term leases, we believe that the partnership
could be expected to generate income at or near the time of the
gifts. The record fails to establish, however, that any
ascertainable portion of the income would flow steadily to the
donees. To the contrary, the record shows that the partnership’s
income did not flow steadily to the donees--there were no
distributions in 1997 or 2001.
Pursuant to the partnership agreement, profits of the
partnership were distributed at the discretion of the general
partner, except when otherwise directed by a majority in interest
of all the partners, both limited and general. Furthermore, the
partnership agreement stated that “annual or periodic
distributions to the partners are secondary to the partnership’s
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primary purpose of achieving a reasonable, compounded rate of
return, on a long-term basis, with respect to its investments.”
Petitioners allege that the partnership is expected to make
distributions to cover the donees’ income tax liabilities arising
from the partnership’s activities. Section 7.3 of the
partnership agreement, however, clearly makes such distributions
discretionary: “Neither the partnership nor the general partner
shall have any obligation to distribute profits to enable the
partners to pay taxes on the partnership’s profits.” Because the
timing and amount of any distributions are matters of pure
speculation, the donees acquired no present right to use,
possess, or enjoy the income from the partnership interests.
Without citation of legal authority, petitioners contend
that the general partner has a “strict fiduciary duty” to make
income distributions to the donees. We are not persuaded that
such a fiduciary duty, if it exists, establishes a present
interest in a transferred limited partnership interest where the
limited partner lacks withdrawal rights.10 Moreover, because (as
10
As has been observed elsewhere:
In many respects a limited partner who has no
withdrawal rights is much like a beneficiary of a
discretionary trust whose only rights with respect to
the trust consist of the right to trust distributions
which may be withheld at the discretion of the trustee.
Regardless of the general partner’s fiduciary duties,
there is no certainty that the limited partner will
receive current distributions from the partnership.
* * * [Kalinka, “Should the Gift of a Limited Partnership
(continued...)
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previously discussed) the donees are not substituted limited
partners, there is significant question as to whether under
Nebraska law the general partner owes them any duty other than
loyalty and due care.11 Cf. Kellis v. Ring, 155 Cal. Rptr. 297
(Ct. App. 1979) (holding that under California law the assignee
of a limited partner’s partnership interest could not bring suit
against the general partner for alleged breaches of fiduciary
duty).
In sum, petitioners have failed to show that the gifts of
partnership interests conferred on the donees an unrestricted and
noncontingent right to immediately use, possess, or enjoy either
the property itself or income from the property. We therefore
hold that petitioners are not entitled to exclusions under
section 2503(b) for their gifts of partnership interests.
10
(...continued)
Interest Constitute a Future Interest?”, Taxes, Apr. 1998,
at 12, 18.]
11
Pursuant to the Nebraska Uniform Limited Partnership Act,
an assignee of a limited partnership interest may become a
limited partner if and to the extent that the partnership
agreement so provides and all other partners consent. Neb. Rev.
Stat. Ann. sec. 67-274(a) (1981). As previously discussed, it
appears that the donees did not become substituted limited
partners in the partnership. With respect to persons who are not
partners of a limited partnership, the general partner has the
liabilities of a partner in a partnership without limited
partners. Neb. Rev. Stat. Ann. sec. 67-256 (1981). Under
Nebraska law, the only fiduciary duty such a partner owes to
other partners is the duty of loyalty and due care. Neb. Rev.
Stat. Ann. sec. 67-424(1), (2), and (3) (1997).
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To reflect the foregoing,
Decisions will be entered
for respondent.