# Bailey v. Commissioner

> United States Tax Court · March 31, 1988 · 90 T.C. 558

URL: https://www.frixlaw.com/law-library/cases/4599055

## Case

- **Full name:** Guy B. Bailey, Jr., and Lois M. Bailey, <sup id="fnr_fnote1"><a href="fn_fnote1" id="">1</a></sup> v. Commissioner of Internal Revenue
- **Court:** United States Tax Court
- **Decided:** March 31, 1988
- **Citations:** 90 T.C. 558; 90 T.C. No. 37; 1988 U.S. Tax Ct. LEXIS 37
- **Precedential status:** Published
- **Opinion:** Opinion
- **Judges:** Pajak
- **Cited by:** 23 later opinions in the Frix Law Library

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## Opinion text

Guy B. Bailey, Jr., and Lois M. Bailey, et al., 1 Petitioners v. Commissioner of Internal Revenue, Respondent
Bailey v. Commissioner
Docket Nos. 10193-78, 12885-80, 21771-81, 4505-82, 3781-85, 18288-85, 18721-85, 18790-85, 18966-85, 19016-85
United States Tax Court
90 T.C. 558 ; 1988 U.S. Tax Ct. LEXIS 37 ; 90 T.C. No. 37 ;
March 31, 1988 ; As amended April 22, 1988; As amended April 25, 1988 March 31, 1988 , Filed
*37 Decision will be entered under Rule 155 in docket No. 4505-82 and docket No. 3781-85 .
Appropriate orders will be issued in all other dockets .
Petitioner-husbands claimed deductions and investment tax credits in connection with motion pictures through their interests as limited partners in either of two partnerships. Held :
1. The partnerships did not acquire depreciable interests in the motion pictures but purchased contractual rights to payments contingent on the success of the respective motion picture. Durkin v. Commissioner , 87 T.C. 1329 (1986) , and Tolwinsky v. Commissioner , 86 T.C. 1009 (1986) , followed.
2. The partnerships are entitled to depreciate their bases in the contractual rights and their bases are determined.
3. The partnerships were engaged in their motion picture activities for profit.
4. The partnerships' nonrecourse purchase money notes must be disregarded for tax purposes since the debts had no substance and thus are not includable in depreciable bases.
5. The partnerships are not entitled to interest deductions on payments made with respect to the purchase money notes.
6. The partnerships *38 are entitled to use the income-forecast method based on their earnings from their contract rights.
7. The retroactive application of sec. 48(k), I.R.C. 1954 , and sec. 804 of the Tax Reform Act of 1976 is not unconstitutional. Petitioner-husbands are entitled to investment tax credits as lenders or guarantors with respect to the motion pictures under the regulations promulgated pursuant to sec. 48(k) .
8. Determinations are made as to substantial underpayments of tax due to tax-motivated transactions within the meaning of sec. 6621(c), I.R.C. 1954 .
Richard A. Levine, Carlton M. Smith , and Albert Rosenblum , for the petitioners.
Gerald A. Thorpe , for the respondent.
Scott, Judge . Pajak , Special Trial Judge .
SCOTT; PAJAK
*559 OPINION
These cases were assigned to and heard by Special Trial Judge John J. Pajak , pursuant to the provisions of section 7456 (redesignated as section 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, section 1556 , 100 Stat. 2755 ) of the Code and Rule 180 et seq. 2 The Court agrees with and adopts the Special Trial Judge's opinion which is set forth below.
*39 OPINION OF THE SPECIAL TRIAL JUDGE
Pajak , Special Trial Judge : In these consolidated cases, 3 Respondent determined deficiencies in Federal income taxes due from petitioners as follows: *560 Petitioners Docket No. Taxable year Deficiency
Bernard B. Neuman 3781-85 1973 $ 7,534.40
and Miriam Neuman 1974 3,451.00
1975 1,365.85
1976 1,119.50
1977 30.81
Guy B. Bailey, Jr., 10193-78 1974 18,342.50
and Lois M. Bailey 4505-82 1975 222,565.42
1976 75,325.75
Norman B. Levy 12885-80 1974 14,096.00
and Helene Levy 1975 25,277.00
1976 46,815.00
Henry Milgram 21771-81 1971 2,059.00
and Toby Milgram 1972 2,059.00
1974 38,153.00
19016-85 1975 2,447.00
1976 90,419.00
1977 1,212.00
Henry Milgram 18966-85 1978 5,754.00
and Carol Milgram 1979 1,210.00
William Milgram 18721-85 1971 4,975.00
and Harriet Milgram 1974 25,887.00
1975 77,872.00
1976 160,000.00
1977 2,177.00
William Milgram 18790-85 1978 7,522.00
1979 3,146.00
William Milgram 18288-85 1980 83,823.00
and Joyce Milgram
*40 Respondent also determined an addition to tax under section 6651(a)(1) in the amount of $ 1,834.25 for the year 1974 in docket No. 10193-78.
Certain issues in these cases were severed and consolidated for the purposes of trial, briefing, and opinion. These issues arise out of activities of two partnerships, Persky-Bright Associates (Persky-Bright) and Vista Co. (Vista).
After concessions, the issues for decision are: (1) Whether the partnerships purchased interests in motion pictures, and, if so, the nature of their purchases; (2) whether the partnerships constituted activities not engaged in for profit within the meaning of section 183 ; (3) whether the nonrecourse notes should be included in the basis of the partnerships' interests in the motion pictures, and, if not, the determination of the basis of the partnerships' interests; (4) whether the partnerships may deduct interest on the *561 nonrecourse notes; (5) whether the partnerships are entitled to depreciation deductions under the income-forecast method; (6) whether each petitioner is entitled to an investment credit; and (7) whether petitioners are subject to an increased rate of interest under section 6621(d) (now section *41 6621(c) ) 4 for substantial underpayments attributable to tax-motivated transactions.
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
Petitioners Guy B. Bailey, Jr., and Lois M. Bailey resided in Coral Gables, Florida, when their petition was filed. Petitioners Norman B. Levy and Helene Levy resided in Woodland Hills, California, at the time their petition was filed. Petitioners Bernard B. Neuman and Miriam Neuman resided in Skokie, Illinois, when their petition was filed. Petitioners Henry Milgram and Toby Milgram resided in Penn Valley, Pennsylvania, and Bala Cynwyd, Pennsylvania, respectively, at the time their petition was filed. Petitioners Henry Milgram and Carol Milgram resided *42 in Penn Valley, Pennsylvania, at the time their petition was filed. Petitioners William Milgram and Harriet Milgram resided in Boca Raton, Florida, and Elkins Park, Pennsylvania, respectively, at the time their petition was filed. Petitioner William Milgram resided in Boca Raton, Florida, when his petition was filed. Petitioners William Milgram and Joyce Milgram resided in Boca Raton, Florida, when their petition was filed.
On their pertinent Federal income tax returns, petitioner-husbands as partners in Persky-Bright and Vista claimed deductions and investment tax credits. Respondent disallowed the claimed deductions and investment credits on a variety of grounds.
*562 Background Persky-Bright and Vista are two of a number of film partnerships organized by Lester Persky (Persky) and Richard Bright (Bright). Persky, after an advertising and public relations career, was involved with the production of several motion pictures in the late 1960s. Bright was experienced in the fields of taxation and cash management, and was a financial advisor who specialized in agricultural and real estate investments before joining forces with Persky. They met in 1971, when Persky was *43 attempting to find an American distributor for two foreign films. They became the general partners of a limited partnership which purchased the two films. Persky and Bright were not satisfied with the independent distributor of those films.
In 1973, Columbia Pictures, Inc. (Columbia), a major distributor, was in desperate financial condition, nearing bankruptcy. It had experienced operating losses in excess of $ 100 million during the prior 3 years and had an approximate net worth of only $ 8 million. Columbia was over $ 250 million in debt and the banks refused to extend any further credit. The banks insisted on a change of management.
Burton Marcus (Marcus), a tax lawyer, became the vice president and general counsel of Columbia. He and several other new operating officers determined that Columbia's most potent source of cash was through the distribution of films and that they would not give up the right to distribute their films. They estimated that approximately $ 40 million was needed to produce the films they wanted to distribute. Columbia had $ 25 million at the time. To raise part of the difference, Columbia sold its corporate headquarters building at a bargain price *44 of $ 11 million, its television stations in Salt Lake City, New Orleans, and Puerto Rico, and its Learning Corporation.
To raise additional funds, Marcus decided to develop a program to sell films. 5 After doing a cost analysis, Marcus decided that he would price the films at warranted cost plus at least a 25-percent markup.
*563 The first film Columbia decided to sell was "Summer Wishes, Winter Dreams." Marcus learned that Persky and Bright wanted to buy the film. In late 1973, Marcus met with Persky and Bright to arrange the sale of "Summer Wishes, Winter Dreams" to Persky-Bright. Persky and Bright did not have any independent projections of profit made before contracting for the film.
In 1974, Marcus met with Persky and Bright to arrange the sale of a package of four films to Vista, the *45 other partnership involved in this case. Again, Persky and Bright did not have any independent projections of profit made before contracting to buy the film package.
Ultimately, Columbia sold 10 to 15 films to partnerships organized by Persky and Bright.
I
Persky-Bright Persky-Bright is a New York limited partnership formed on October 15, 1973. Persky and Bright are the general partners, each owning a 2.5-percent interest in the profits and losses and a 0.5-percent interest in the investment tax credit and 2.5-percent interest in the cash-flow of the partnership.
Persky and Bright prepared an informal offering memorandum for prospective partners. The memorandum was similar to the offering memorandum prepared in connection with the formation of the Vista partnership.
During the years in issue, the limited partners held in aggregate a 95-percent interest in the profits and losses and a 99-percent interest in the investment tax credit. The total capital contributed to Persky-Bright by its partners was $ 465,000, of which $ 300,000 was contributed in 1973, and $ 165,000 was contributed in 1974.
The film "Summer Wishes, Winter Dreams" stars Joanne Woodward, Martin Balsam, and Sylvia *46 Sydney. It was produced by Jack Brodsky and directed by Gilbert Cates. The story concerns a middle-aged woman who must cope with the disappointments of her life, such as an unfulfilling marriage, a nagging mother, and a son who is gay. The movie dramatizes the problems and conflicts within the *564 family. The film was rated PG by the Motion Picture Association of America's Classification and Ratings Administration. Persky and Bright viewed "Summer Wishes, Winter Dreams" prior to its purchase. "Summer Wishes, Winter Dreams" was completed and edited prior to October 15, 1973, the date on which Persky-Bright was formed.
Persky-Bright and Columbia executed simultaneous purchase and distribution agreements with respect to "Summer Wishes, Winter Dreams" on October 15, 1973.
On that date, Persky-Bright entered into an agreement with Columbia to purchase all rights, title, and interest in "Summer Wishes, Winter Dreams" for a total purchase price of $ 2 million. Pursuant to this agreement, Persky-Bright acquired legal title and ownership of the copyright and negative of the film. The purchase price was based on 133 1/3 percent of the amount Columbia warranted as the production *47 cost of the film, which was no less than $ 1.5 million. In determining negative cost during 1973, a factor of 15 percent of the direct production costs would ordinarily represent overhead costs. Persky-Bright was able to negotiate a 5-percent overhead cost in its purchase agreement. The completed production cost of "Summer Wishes, Winter Dreams" was as follows: Direct production costs $ 1,458,529
6-Percent completion fee 87,514
Interest to date of purchase 175,000
15-Percent overhead 218,779
1,939,822
The purchase agreement 6 provided for payment of the $ 2 million purchase price as follows: Upon execution of the agreement $ 75,000 and delivery
of a $ 1,850,000
nonrecourse
promissory note
On or before 12/15/73 $ 25,000
On or before 9/15/74 $ 50,000
In addition, Persky-Bright agreed to pay interest on the note on December 15, 1973, and September 15, 1974, in the amounts of $ 125,000 and $ 100,000, respectively. The promissory *565 note was due 10 years from the date of the agreement and bore interest at the rate of 12 percent for the first year and 10 percent thereafter.
*48 On October 15, 1973, Persky-Bright paid Columbia $ 75,000 representing its initial payment of the purchase price. On December 15, 1973, pursuant to the above provisions, Persky-Bright paid $ 150,000, of which $ 25,000 represented a payment of the purchase price and $ 125,000 represented a payment of interest. On September 15, 1974, pursuant to the above provisions, Persky-Bright paid $ 150,000, of which $ 50,000 represented payment of the purchase price and $ 100,000 represented interest.
The nonrecourse note was secured by a first lien on the film and a security interest in the revenues derived from the film. Columbia was to be paid 75 percent of the distributable gross receipts after various deductions until it had received in full the principal amount of the note together with interest, with the remaining 25 percent to be paid to Persky-Bright. All such payments to Columbia were to be credited first to interest and then to principal.
On October 15, 1973, Persky-Bright also entered into an agreement with Columbia under which Columbia had the exclusive right to distribute "Summer Wishes, Winter Dreams" for a period of 10 years. It was anticipated by all concerned that a film *49 would produce most of its revenues in the first 2 years of showing and would have a useful life of about 10 years.
The agreement, as amended on June 24, 1974, gave Columbia an option to extend its distribution rights in perpetuity by paying the greater of $ 15,000 or the fair market value of the distribution rights at the time the distribution rights were extended. The fair market value for such an extension was to be based on the average price paid by Columbia to extend the term of agreements relating to the distribution of comparable pictures pursuant to which agreements Columbia had acquired the distribution rights for a 10-year term and had exercised a right to extend the term in perpetuity.
The agreement provided that Persky-Bright had the right to approve the overall sales and advertising policy in connection with "Summer Wishes, Winter Dreams" and to *566 inspect copies of exhibition contracts and details of advertising expenditures and campaigns. Approval of such sales and advertising policies could not be withheld unreasonably. Columbia understood this provision as merely a right of consultation on these matters.
Persky-Bright was also entitled to receive the credit *50 "A Persky-Bright Associates Feature" on all positive prints of the film and the credit "A P-B Associates Feature" in all paid advertising of 16 columnar inches (224 lines) or more.
Under the amended distribution agreement, Columbia was required to collect all film rentals ("gross receipts") from the exhibitors. Columbia was also entitled to reimburse itself from gross receipts for motion picture association dues and taxes. Columbia was then entitled to retain a portion of gross receipts from theatrical and television distribution as a distribution fee as follows: $ 7.5 million Excess of $ 7.5 million
(i) United States 30% 35%
(ii) England and Canada 35 40
(iii) Rest of the world 40 45
(iv) Outright sale 10 10
Columbia was next entitled to retain gross receipts equal to certain third-party participation and deferments as set forth in the agreement. 7 The remaining gross receipts after deduction for the above items were defined in the agreement as "adjusted gross receipts."
*51 Columbia was required to deposit the adjusted gross receipts it collected from the distribution of "Summer Wishes, Winter Dreams" into a special bank account. The bank was instructed that payments from this account were to be made to Columbia and Persky-Bright in accordance with the agreements between the parties.
Pursuant to the amended distribution agreement, Columbia was reimbursed for releasing costs incurred by Columbia for "Summer Wishes, Winter Dreams." The portion reimbursed was calculated under a complex formula which resulted in a deferred reimbursement of the expenses. During 1974, Persky-Bright agreed that after the promissory *567 note was repaid, Columbia would be able to "recoup off the top" any releasing costs thereafter incurred by it.
Columbia and Vista entered into a series of temporary extensions of the terms of the distribution agreement and the due date of Persky-Bright's promissory note for "Summer Wishes, Winter Dreams." As of the date of trial, Columbia and Persky-Bright had agreed to extend the terms of the distribution agreement and the due dates of these nonrecourse notes in order to give themselves sufficient time to establish the fair market value *52 of the extended distribution rights of the film.
"Summer Wishes, Winter Dreams" was first exhibited to the public on October 17, 1973. It was ultimately exhibited throughout the United States, Canada, and in more than 47 other countries.
Columbia maintained lists of play dates at which "Summer Wishes, Winter Dreams" was scheduled to be exhibited. In addition, Columbia pictures maintained records of the daily gross receipts from the film for each theater at which the film was exhibited.
Columbia furnished to Persky-Bright distribution statements reflecting gross receipts from "Summer Wishes, Winter Dreams" and the application of gross receipts in payment of Motion Picture Association taxes and dues, distribution fees, pre-releasing costs, and releasing costs. Such distribution statements were prepared monthly commencing with the period ended December 29, 1977, and quarterly commencing with the period ended November 27, 1976.
The schedule beginning on page 568 summarizes the gross receipts and cash expenses attributable to the distribution of the motion picture "Summer Wishes, Winter Dreams," as set forth in the distribution statements for the film and as reported by Persky-Bright *53 on its Federal partnership income tax returns for the taxable years 1973 through 1984, as well as the application of these receipts to principal and interest on the nonrecourse note. *568 Summer Wishes, Winter Dreams
1973 1974
I. Gross receipts
United States:
Theatrical $ 150,000 $ 849,037
Nontheatrical and trailer 0 63,949
Network television 0 0
Pay television 0 0
Television syndication 0 $ 150,000 0 $ 912,986
Foreign 0 165,754
Total gross receipts 150,000 1,078,740
II. Expenses before debt service
Distribution fees 0 368,975
Releasing costs 0 224,635
Motion Picture Association
dues and taxes 0 23,832
Total 0 617,442
Distributable gross receipts 150,000 461,298
III. Promissory note payments
Principal 34,000 277,730
Interest 1 78,500 $ 112,500 2 46,419 324,149
Net after debt service 37,500 137,149
Summer Wishes, Winter Dreams
1975 1976
I. Gross receipts
United States:
Theatrical $ 204,771 ($ 1,956)
Nontheatrical and trailer 20,300 2,837
Network television 0 0
Pay television 33,865 1,862
Television syndication 0 $ 258,936 0 $ 2,743
Foreign 166,995 54,058
Total gross receipts 425,931 56,801
II. Expenses before debt service
Distribution fees 127,972 18,851
Releasing costs 83,327 19,132
Motion Picture Association
dues and taxes 14,843 4,610
Total 226,142 42,593
Distributable gross receipts 199,789 14,208
III. Promissory note payments
Principal 38,092 0
Interest 133,575 171,667 10,656 10,656
Net after debt service 28,122 3,552
*54
*569 Summer Wishes, Winter Dreams
1977 1978
I. Gross receipts
United States:
Theatrical ($ 15,880) $ 803
Nontheatrical and trailer 3,778 1,359
Network television 0 750,000
Pay television 480 320
Television syndication 0 ($ 11,622) 111,120 $ 863,602
Foreign 41,271 34,415
Total gross receipts 29,649 898,017
II. Expenses before debt service
Distribution fees 11,935 271,107
Releasing costs 8,209 248,106
Motion Picture Association
dues and taxes (4,182) 1,225
Total 15,962 520,438
Distributable gross receipts 13,687 377,579
III. Promissory note payments
Principal 0 0
Interest 10,266 10,266 283,184 283,184
Net after debt service 3,421 94,395
Summer Wishes, Winter Dreams
1979 1980
I. Gross receipts
United States:
Theatrical $ 1,387 ($ 1,408)
Nontheatrical and trailer 706 761
Network television 0 0
Pay television 126 0
Television syndication 75,089 $ 77,308 56,329 $ 55,682
Foreign 35,146 42,832
Total gross receipts 112,454 98,514
II. Expenses before debt service
Distribution fees 34,907 32,045
Releasing costs 34,668 36,446
Motion Picture Association
dues and taxes 3,565 3,317
Total 73,140 71,808
Distributable gross receipts 39,314 26,706
III. Promissory note payments
Principal 0 0
Interest 29,483 29,483 20,029 20,029
Net after debt service 9,831 6,677
*55 *570 Summer Wishes, Winter Dreams
1981 1982
I. Gross receipts
United States:
Theatrical $ 100 $ 25
Nontheatrical and trailer 56 979
Network television 0 0
Pay television 0 0
Television syndication 36,271 $ 36,427 22,122 $ 23,126
Foreign 51,195 67,472
Total gross receipts 87,622 90,598
II. Expenses before debt service
Distribution fees $ 27,552 34,254
Releasing costs 29,197 30,841
Motion Picture Association
dues and taxes 8,950 1,764
Total 65,699 66,859
Distributable gross receipts 21,923 23,739
III. Promissory note payments
Principal 0 0
Interest 16,450 16,450 17,803 17,803
Net after debt service 5,473 5,936
Summer Wishes, Winter Dreams
1983 1984
I. Gross receipts
United States:
Theatrical 0 0
Nontheatrical and trailer $ 391 $ 985
Network television 0 0
Pay television 0 0
Television syndication 10,947 $ 11,388 6,370 $ 7,355
Foreign 6,048 11,982
Total gross receipts 17,386 19,337
II. Expenses before debt service
Distribution fees 5,898 5,574
Releasing costs 6,635 5,741
Motion Picture Association
dues and taxes (278) 3,560
Total 12,255 14,875
Distributable gross receipts 5,131 4,462
III. Promissory note payments
Principal 0 0
Interest 3,848 3,848 3,346 3,346
Net after debt service 1,283 1,116
*56 *571 Summer Wishes, Winter Dreams
Cumulative (1973-1984)
I. Gross receipts
United States:
Theatrical $ 1,186,879
Nontheatrical and trailer 96,101
Network television 750,000
Pay television 36,653
Television syndication 318,248 $ 2,387,881
Foreign 677,168
Total gross receipts 3,065,049
II. Expenses before debt services
Distribution fees 939,070
Releasing costs 726,937
Motion Picture Association dues and taxes 61,206
Total 1,727,213
Distributable gross receipts 1,337,836
III. Promissory note payments
Principal 349,822
Interest 1 653,559 1,003,381
Net after debt service 334,455
Persky-Bright kept its books and records at the offices of the Persky-Bright organization in New York. In 1976, Sherry Polen (Polen), a certified public accountant, was employed by the organization. At that time, in addition to Persky and Bright and their secretaries, the organization employed an assistant to Persky, a controller, and a story editor. Persky, Bright, and Polen reviewed the distribution statements for *57 mathematical errors and charges plainly inconsistent with the terms of the purchase and distribution statements.
In September 1975, Persky-Bright retained the services of Sidney Finger of Solomon & Finger to audit the records of Columbia on behalf of Persky-Bright. Solomon & Finger conducted periodic audits of the records of Columbia concerning "Summer Wishes, Winter Dreams." As a result of these audits, Persky-Bright made claims against Columbia for additional money due. Prior to 1983, claims were made with respect to the underreporting of gross receipts and the charging of improper releasing costs, Motion Picture Association dues, foreign taxes, and distribution *572 fees. As a result of these claims, Columbia made adjustments to its distribution statements for "Summer Wishes, Winter Dreams."
Persky-Bright retained the services of Margold, Ersken & Wang and, later, Frank Zimmerman & Co., P.C., to prepare annual financial statements for Persky-Bright.
During the years 1973 through 1984, Persky-Bright incurred and paid the following management fees and administration expenses, professional fees, travel and entertainment expenses, and sundry expenses: Administrative, professional,
Year Management fees travel, and sundry
1973 $ 75,000 $ 13
1974 0 6,364
1975 15,000 2,971
1976 0 3,510
1977 0 1,591
1978 0 5,517
1979 0 1,686
1980 0 1,273
1981 0 4,849
1982 0 8,019
1983 0 2,951
1984 0 3,803
*58 The parties stipulated that if the Court determines that Persky-Bright was engaged in an activity for profit, the management fees shall be treated as follows: $ 18,000 shall be treated as nondeductible, nonamortizable syndication expenses; $ 18,000 shall be treated as ordinary and necessary expenses fully deductible in 1973; $ 27,000 shall be added into the partnership's basis for the film "Summer Wishes, Winter Dreams" in 1973; and $ 27,000 shall be capitalized and amortized annually in equal amounts over 10 years, beginning in 1973. They also stipulated that if the Court determined that Persky-Bright was engaged in an activity for profit, the other listed expenses would be deductible in the years paid.
Persky-Bright is entitled to employ the income-forecast method of computing depreciation. On its partnership tax returns, Persky-Bright employed a variation of the income-forecast method of depreciation. Vista requested from Columbia estimates of Columbia's total gross receipts and distribution expenses. Columbia's estimates included estimated *573 television gross receipts and television releasing costs. Persky-Bright used Columbia's estimates with several modifications *59 to calculate depreciation. Persky-Bright did not include Columbia's estimated television gross receipts and television releasing costs in its calculations. At the end of each taxable year, Persky-Bright estimated future net receipts of "Summer Wishes, Winter Dreams." In calculating net receipts, Persky-Bright subtracted from gross receipts estimated distribution fees, releasing expenses, and Motion Picture Association dues and taxes.
Persky-Bright arrived at the amount it deducted as depreciation in the following manner: first, it multiplied the $ 2 million purchase price of "Summer Wishes, Winter Dreams" by a fraction, the numerator of which was the net receipts received by the partnership from the film in that year, plus all previous years, and the denominator of which was the estimated future net receipts, plus the total net receipts received in that year and all previous years; and second, it subtracted from this amount all depreciation previously claimed. Depreciation deducted by Persky-Bright was computed by the Persky-Bright organization and the amounts computed were then given to an independent accounting firm which prepared the returns.
For the taxable years 1973-84, Persky-Bright *60 filed Federal income tax returns reporting the following amounts of income and expenses: Other Income
Year Income Interest Depreciation expenses 1 (loss)
1973 $ 150,000 2 $ 203,500 $ 510,000 $ 75,013 ($ 638,513)
1974 1,078,740 3 146,419 757,200 623,806 (448,685)
1975 425,931 133,575 246,400 244,113 (198,157)
1976 56,801 10,656 142,000 46,103 (141,958)
1977 29,649 10,266 0 17,553 1,830
1978 898,071 283,184 122,000 525,955 (33,122)
1979 112,454 29,483 1,800 74,826 6,345
1980 98,514 20,029 0 73,081 5,404
1981 87,622 16,450 10,000 70,548 (9,376)
1982 91,808 17,803 32,600 74,878 (33,473)
1983 17,945 3,848 19,600 15,484 (20,987)
1984 19,343 3,346 53,800 18,678 (56,481)
Total 3,066,878 878,559 1,895,400 1,860,038 (1,567,173)
*574 *61 "Summer Wishes, Winter Dreams" constitutes a "qualified film" within the meaning of section 48(k)(1)(B) . When Persky-Bright placed the film in service on October 17, 1973, it constituted "new section 38 property (determined without regard to useful life)" as to Persky-Bright within the meaning of section 48(k)(1)(A)(i) .
For the taxable years 1973 through 1984, Persky-Bright made cash distributions to the partners as follows: 1973 0
1974 $ 134,007
1975 38,468
1976 18,418
1977 3,168
1978 74,158
1979 10,529
1980 0
1981 0
1982 15,921
1983 0
1984 0
Total 294,669
Petitioner Bernard Neuman (Neuman) acquired a limited partnership interest in Persky-Bright in 1973 and contributed $ 7,750 to the partnership's capital. During 1973 and 1974, Neuman held a 1.583-percent interest in the profits and losses and a 1.65-percent interest in the investment tax credit of Persky-Bright. During 1975 and 1976, Neuman held a 1.577-percent interest in the profits and losses of Persky-Bright.
On their Federal income tax returns, petitioners Bernard and Miriam Neuman deducted the following amounts as Bernard Neuman's distributive share of loss from Persky-Bright: 1973 ($ 10,108)
1974 (7,103)
1975 (3,125)
1976 (2,239)
*62 The 1979 Federal income tax return was not placed in evidence. On their 1973 Federal income tax return, petitioners Bernard and Miriam Neuman claimed $ 2,310 as Bernard Neuman's distributive share of the investment tax credit of Persky-Bright. The 7-percent investment tax credit was *575 based on the $ 2 million purchase price of "Summer Wishes, Winter Dreams."
II
Vista Vista is a New York limited partnership formed by Persky and Bright in November 1974. The partnership's stated purposes were to acquire four films and render production services with respect to a fifth film. 8 Richless Associates is a partnership whose partners are Persky and Bright. During the years in issue, Richless Associates was the sole general partner of Vista, owning a 4.94-percent interest in the profits, losses, and investment tax credit of Vista and a 10.29-percent interest in those items as a limited partner, for a total of 15.23 percent.
*63 In connection with the organization of the partnership, Persky and Bright prepared a private placement memorandum dated December 26, 1974, for prospective partners. The memorandum contained the following statements:
INVESTMENT IN THE UNITS INVOLVES A HIGH DEGREE OF RISK, IS SUITABLE ONLY FOR PERSONS OF SUBSTANTIAL FINANCIAL MEANS WHO CAN AFFORD TO SUSTAIN A TOTAL LOSS OF THEIR INVESTMENT AND IS NOT RECOMMENDED FOR PERSONS WHOSE MARGINAL FEDERAL INCOME TAX BRACKETS AFTER TAKING INTO ACCOUNT THE LOSSES INCURRED AS A RESULT OF SUCH INVESTMENT IS NOT AT LEAST 50%.
* * * *
The motion picture business is highly speculative and has historically involved a substantial degree of risk. The ultimate profitability of the Pictures to the Partnership will depend on many factors over which the Partnership will have no control, e.g., unpredictable critical reviews and changeable public tastes which cannot be ascertained in advance with any degree of certainty. Even if the Pictures were critical or artistic successes, there is no assurance that the Pictures will be economic successes.
* * * *
*576 In order for the Partnership to recoup its cash outlay (representing its down payment and its *64 advance payment of interest) in connection with the purchase of each of the Acquired Pictures, the General Partners estimate that Gross receipts (as said term is hereinafter defined, see p. 20) in the following amounts will have to be generated from the distribution of each of the Acquired Pictures: Estimated worldwide gross
Cash outlay of receipts required to
Acquired picture partnership recoup cash outlay
Streisand $ 2,000,000 $ 21,000,000
Bronson 1,250,000 11,000,000
Beatty 1,200,000 12,000,000
Hackman 1,200,000 10,500,000
There is no assurance, however, that the estimated amount of Gross Receipts set forth above for each Acquired Picture will be attained.
* * * *
The Partnership has entered into separate agreements (hereinafter separately referred to as the "Purchase Agreement" and collectively referred to as the "Purchase Agreements") with (i) Gelderse Belleggingsmattschappij N.V. ("Gelderse") for the purchase of the Streisand Picture; (ii) Zeeuwse Belleggingsmaatschappij N.V. ("Zeeuwse") for the purchase of the Bronson Picture; (iii) Columbia for the purchase of the Beatty Picture; and (iv) Gelderse for the purchase of the Hackman Picture. *65 Gelderse and Zeewuse have assigned their entire respective interests in the Purchase Agreements to Columbia and together with Columbia are herein sometimes individually referred to as the "Seller" and collectively referred to as the "Sellers". The Partnership and Columbia have entered into agreements amending the Purchase Agreements with Gelderse and Zeeuwse in certain respects.
In addition, the private placement memorandum contains nine pages of discussion of the Federal tax consequences if the Federal tax laws are changed or if the Internal Revenue Service successfully challenges the deductions and credits claimed by the partnership on its Federal income tax returns. A 46-page opinion letter of a law firm, which discusses the Federal tax consequences associated with an investment in Vista, is part of the memorandum. That opinion letter states in part as follows:
The motion picture industry is highly speculative and the success or failure of any one motion picture is difficult if not impossible to predict because of many factors. The amount expended on the production of a motion picture usually is no indication of whether or not the motion picture will be profitable. You have *66 represented to us that substantial gross receipts will be required in order to produce sufficient revenues so *577 that the Partnership can recoup the amounts expended for its projects and to repay the indebtedness incurred. You have also informed us that prior motion pictures in which Charles Bronson, Barbra Streisand, Warren Beatty and Gene Hackman have starred, have been highly successful and that at the present time it is impossible to predict how Daybreak will do at the box office.
* * * *
You have represented to us that the indebtedness incurred with respect to the Acquired Pictures was incurred pursuant to arm's length negotiation between unrelated parties. As a general rule, fair market value is defined as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having knowledge of all relevant facts. You have also represented to us that the price to be paid for the Acquired Picture is based on what you in your experienced opinion considered each Acquired Picture to be worth after viewing each Acquired Picture, receiving and reviewing projections of revenue from each Acquired *67 Picture, and evaluating the stature of the stars, the producer and the director. While all of the foregoing indicates arm's length dealing in establishing that the non-recourse indebtedness does not exceed fair market value, there can be no guarantee that such determination will not be questioned by the Service.
Contrary to the statement in the opinion letter, neither Persky, Bright, nor anyone else acting on behalf of Vista viewed each acquired picture prior to purchase. The memorandum, itself, contains no projections of the gross receipts the promoters expected each film to generate or the amount of expenses expected to be incurred. Neither Persky nor Bright sought independent expert advice as to the potential economic success of the four films.
In late summer or early fall of 1974, Persky and Bright met with representatives of Columbia to discuss the acquisition by Vista of "Funny Lady," "Breakout," "Shampoo," and "Bite the Bullet." These films were in the process of being made. Vista and Columbia anticipated that "Funny Lady" would be the most successful of these films. "Shampoo" was much more successful than anticipated by Vista and Columbia.
The principal photography was *68 finished and the films were substantially completed prior to December 20, 1974, the date of purchase. After that date, the films were in post production. During post production, a film is edited, the sound track and sound effects are added, the dialogue is put *578 on the soundtrack, the film is screened for the motion picture board, a composite print is manufactured which combines the separate soundtracks and optical tracks and adds the opening titles and closing credits, the film is previewed for audiences, positive prints are manufactured, and the sound for musical numbers is recorded. During post production, up to six or seven different versions of a film may be put together. Post production takes at least 6 months.
"Funny Lady" stars Barbra Streisand, James Caan, Roddy McDowall, Omar Sharif, and Ben Vereen. It was produced by Ray Stark and directed by Herbert Ross. "Funny Lady" is a sequel to the movie "Funny Girl" which also stars Barbra Streisand and Omar Sharif and was produced by Ray Stark and directed by Herbert Ross. The film is about the life of Fanny Brice.
"Breakout" stars Charles Bronson, Jill Ireland, Robert Duvall, John Huston, Randy Quaid, and Sheree *69 North. It was produced by Robert Chartoff and Irwin Winkler, and directed by Tom Gries. "Breakout" is based on a true story of an innocent man sent to a Mexican prison as a result of a frameup engineered by his wealthy grandfather. After several unsuccessful attempts to escape, the prisoner is rescued.
"Shampoo" stars Warren Beatty, Julie Christie, Goldie Hawn, Jack Warden, Lee Grant, Tony Bill, and Carrie Fisher. It was produced by Warren Beatty and directed by Hal Ashby. The story concerns the illicit romantic entanglements of a Hollywood hairdresser.
"Bite the Bullet" stars Gene Hackman, Candice Bergen, James Coburn, Jan-Michael Vincent, Ben Johnson, Ian Bannen, and Dabney Coleman. "Bite the Bullet" is a story involving a 700-mile horserace across Nevada and New Mexico in about 1905.
After release of the films, the Motion Picture Association of America's Classification and Rating Administration rated Shampoo "R" and the other films "PG."
Persky and Bright negotiated with representatives of Columbia for the purchase of all rights, title, and interest in each of the four films in the Vista package. The negotiations resulted in a total purchase price of $ 29 million for the *70 *579 four films. Under the purchase agreements, Vista acquired legal title and ownership of the copyright and negative of each of the four films from Columbia. Under the distribution agreements, Columbia retained proprietary rights in each of the four films.
On December 20, 1974, Columbia executed agreements with Gelderse Belleggingsmattschappij N.V. (Gelderse) with respect to "Funny Lady" and "Bite the Bullet" and with Zeeuwse Belleggingsmattschappij N.V. (Zeeuwse) with respect to "Breakout" (then titled "Ten Second Jailbreak"), whereby those parties agreed to transfer all of their right, title, and interest in those films to any third party approved by Columbia. On December 20, 1974, at the direction of Columbia, Gelderse and Zeeuwse executed purchase agreements with Vista to transfer legal title and ownership of the copyright and negative of the respective films to Vista. Vista also executed nonrecourse promissory notes to Gelderse and Zeeuwse pursuant to the purchase agreements for each of the three films. On December 20, 1974, Gelderse and Zeeuwse assigned all their respective rights in the purchase agreement and nonrecourse note relating to each of the three films to *71 Columbia. On December 20, 1974, by agreements with Vista, modifying or amending the purchase agreements, Columbia warranted that Vista had acquired "good title to and full ownership in the Picture and all rights therein" for each of the three films. 9
On December 20, 1974, Columbia and Vista also executed a purchase agreement whereby Vista acquired legal title and ownership of the copyright and negative of Shampoo. Vista executed a nonrecourse promissory note to Columbia pursuant to the purchase agreement.
Columbia warranted that the production cost of *72 each film would be not less than a specified amount. In determining negative cost during 1974, a factor of 15 percent of the direct production costs would ordinarily represent overhead costs. Vista was able to negotiate a 5-percent overhead cost *580 in its purchase agreements. The warranted production cost included the cost of a completion bond or fee, deferments in a specific amount, if any, and an overhead fee of 5 percent of the actual production cost (excluding interest). The purchase price of each film was at least 125 percent of Columbia's warranted production cost of that film.
The completed cost of production of each film was as follows: Direct 6-Percent Interest
production completion to date
cost fee of purchase
Funny Lady $ 8,206,476 $ 492,389 $ 500,000
Breakout 4,616,683 277,003 300,000
Shampoo 4,286,430 257,186 390,000
Bite the Bullet 3,852,702 231,162 390,000
Total
Completed
15-Percent production
Deferments overhead cost
Funny Lady $ 225,000 $ 1,230,971 $ 10,654,836
Breakout 75,000 692,502 5,961,188
Shampoo 200,000 642,964 5,776,581
Bite the Bullet 125,000 577,905 5,176,769
Total 27,569,374
*73 Vista granted Columbia a security interest in each film and in the proceeds derived from the exhibition of the film. Columbia assigned its security interest in each film to the First National Bank of Boston, a secured creditor of Columbia.
Each of the purchase agreements provided for cash payments, the delivery of a nonrecourse note, and the prepayment of interest. Each of the promissory notes was payable solely out of up to 75 percent of the distributable gross receipts as defined in the distribution agreements, with the remainder of distributable gross receipts payable to Vista. Each of the promissory notes was due 10 years from the date of the agreement and bore interest at a rate of 12 percent per year for the first year and 10 percent thereafter. The promissory notes were not cross-collateralized. Some terms of the purchase agreements are set forth below: Nonrecourse
Warranted cost Purchase price Cash note
Funny Lady $ 8 million $ 10.5 million $ 1,000,000 $ 9.5 million
Breakout 5 million 6.5 million 625,000 5.875 million
Shampoo 4.8 million 6.0 million 600,000 5.4 million
Bite the Bullet 4.8 million 6.0 million 600,000 5.4 million
Total 22.6 million 29.0 million 2,825,000 26.175 million
*74 *581 Prepaid
Cash by Cash by Cash by interest 10
12/31/74 3/1/75 6/1/75 by 12/31/74
Funny Lady $ 150,000 $ 600,000 $ 250,000 $ 1,000,000
Breakout 100,000 375,000 150,000 625,000
Shampoo 100,000 375,000 125,000 600,000
Bite the Bullet 100,000 375,000 125,000 600,000
Total 2,825,000
The total capital contributed to Vista by its partners was $ 7,840,000. All of such capital was contributed in 1974. Vista paid $ 5,650,000 to Columbia from its contributed capital in connection with the four films. The $ 2,825,000 cash payments credited to the purchase price were made in accordance with the terms of the purchase agreements. The payments of the $ 2,825,000 designated as interest payments were made on December 20, 1974.
On December 20, 1974, Vista also entered into related distribution agreements with Columbia. *75 Each film was designated as the "Photoplay" in the relevant agreement, and Vista granted Columbia "the exclusive license to distribute and otherwise deal with the Photoplay throughout the world in all media" for a term of 10 years or as extended "in perpetuity" in accordance with the terms of the agreements. It was anticipated by all concerned that a film would produce most of its revenues in its first 2 years of showing and would have a useful life of about 10 years. Columbia was granted an option to extend its distribution rights in perpetuity by paying the greater of $ 25,000 ($ 40,000 in the case of "Funny Lady") or the so-called fair market value of the extended distribution rights at the time the distribution rights were extended. The fair market value for such an extension was to be based on the average price paid by Columbia to extend the term of agreements relating to the distribution of comparable pictures pursuant to which agreements Columbia had acquired the distribution rights for a 10-year term and had exercised a right to extend the term in perpetuity.
The agreements provide that Vista had the right to approve the overall sales and advertising policy in connection *76 with the four films and to inspect copies of exhibition *582 contracts and details of advertising expenditures and campaigns, but such approval could not be unreasonably withheld. Columbia understood these provisions as merely rights of consultation on these matters.
Vista was to receive the credit "A Persky-Bright/Vista Feature" in the main titles on all positive prints of each film, or not less than one-half of a card, and in size of type, not less than 35 percent of the size of type used for the title of the film. In all paid advertising, Vista was to receive either of the following credits: "A Persky/Vista Feature" in the same size type as the words "Directed by" in advertisements 100 lines or larger, or "A P-B/Vista Feature" in size of type comparable to Columbia Pictures credit in advertisements of less than 100 lines.
Under each distribution agreement, Columbia was required to collect all film rentals from the exhibitors and other moneys derived from the film. Columbia was to reimburse itself from the collected receipts for Motion Picture Association dues and taxes paid with respect to the film. The remaining amounts are defined as "gross receipts."
Columbia was next *77 entitled to retain a portion of the gross receipts as distribution fees. The distribution fees to be retained by Columbia in respect of all gross receipts, other than television and outright sales, in millions of dollars were as follows: 32 1/2 Percent 35 Percent
Funny Lady to $ 32 $ 32 to $ 80
Breakout to 14 14 to 28
Shampoo to 14 14 to 35
Bite the Bullet to 14 14 to 28
43 1/2 Percent 45 Percent 50 Percent
Funny Lady $ 80 and
over
Breakout $ 28 and
over
Shampoo $ 35 and
over
Bite the Bullet 28 and
over
For each film, the distribution fees to be retained by Columbia attributable to television and outright sales were 32 1/2 percent and 10 percent, respectively.
Columbia was next entitled to retain an amount of the "gross receipts" equal to certain third-party participations *583 and deferments as set forth in its agreements with Vista. 11 The remaining balance, defined as "adjusted gross receipts," was to be paid into special bank accounts established by Vista. The banks were instructed to pay prereleasing costs in the amounts of $ 500,000 for "Funny Lady," $ 150,000 for "Breakout," $ 200,000 for "Shampoo," and $ 150,000 for *78 "Bite the Bullet." Thereafter, the banks were to pay releasing costs in accordance with formulas developed by the parties. The balance of the adjusted gross receipts was referred to as "distributable gross receipts." Under the purchase agreements, 75 percent of the distributable gross receipts was to be paid to Columbia and 25 percent was to be retained by Vista, with Vista entitled to the minimum percentages of gross receipts as set forth in the amended purchase agreements.
Under the amended purchase agreements, at no time were the amounts of the distributable *79 gross receipts retained by Vista to be less than the following percentages of gross receipts (after deducting therefrom guild payments): Funny Lady 6 1/2 Percent of gross receipts after gross receipts
equaled $ 32 million
Breakout 8 Percent
Shampoo 7 Percent
Bite the Bullet 8 1/4 Percent
The distributable gross receipts were allocated between Columbia and Vista in accordance with the respective purchase agreements, as amended.
Columbia and Vista entered into a series of temporary extensions of the terms of the distribution agreements for all four films and the due dates of Vista's promissory notes for "Funny Lady," "Bite the Bullet," and "Breakout." As of the date of trial, Columbia and Vista had agreed to extend the terms of the distribution agreement and the due dates of these nonrecourse notes in order to give themselves sufficient time to establish the fair market value of the extended distribution rights of the films and to resolve *584 disputes concerning the amounts due Vista from Columbia uncovered by the partnership's most recent audit of Columbia.
Persky approved the distribution and advertising strategies of the four films. During its first run in New York, *80 Warren Beatty and Persky composed the first advertisement for "Shampoo" which ran in the Sunday New York Times. Persky and Beatty thereafter prepared a series of advertisements.
Shampoo was exhibited to the public, beginning in February 1975. It was exhibited thereafter throughout the United States and Canada as well as worldwide in more than 54 countries. On February 16, 1979, "Shampoo" was first exhibited on network television.
Persky attended openings and screenings of "Funny Lady" in various cities. "Funny Lady" was first exhibited to the public beginning in March 1975 and was exhibited throughout the United States and Canada as well as worldwide in more than 51 countries.
"Breakout" opened simultaneously at more than 1,100 theaters throughout the United States during the week of May 21, 1975.
Persky attended openings and screenings of "Bite the Bullet" in various cities. "Bite the Bullet" was first exhibited to the public beginning in June 1975. "Bite the Bullet" was exhibited throughout the United States and Canada as well as worldwide in more than 67 countries.
Columbia maintained records of the daily box office receipts of the four films for each theater at which the *81 films were exhibited. Columbia furnished to Vista weekly sheets summarizing each day's box office receipts as well as reports of future play dates. Columbia also furnished to Vista distribution statements reflecting gross receipts from each film and the application of gross receipts in payment of motion picture association taxes and dues, distribution fees, releasing costs, prereleasing costs, and third-party gross participations. Such distribution statements were prepared monthly commencing with the period ended April 26, 1975, and quarterly commencing with the period ended June 25, 1977, for "Breakout," "Funny Lady," and "Shampoo." Distribution statements for "Bite the Bullet" were prepared and furnished monthly commencing with the *585 period ended June 28, 1975, and quarterly commencing with the period ended August 27, 1977.
The schedules beginning on page 587 summarize the gross receipts and cash expenditures attributable to each of the four films as set forth in the distribution statements for the films and as reported by Vista on its Federal partnership income tax returns for the taxable years 1975 through 1984, as well as the application of those receipts to principal *82 and interest on the nonrecourse notes.
Vista kept its books and records at the offices of the Persky-Bright organization in New York. Sherry Polen kept the books and records of Vista. Persky, Bright, and Polen reviewed each distribution statement for mathematical errors and charges plainly inconsistent with the terms of the purchase and distribution agreements.
In 1975, Vista retained the services of Sidney Finger of Solomon & Finger to audit the records of Columbia on behalf of Vista. Solomon & Finger conducted periodic audits of the records of Columbia concerning the four films. As a result of these audits, Vista made claims against Columbia for additional moneys due. Prior to 1983, claims were made with respect to the underreporting of gross receipts and the charging of improper releasing costs, motion picture association dues, foreign taxes, distribution fees, and third-party participations and deferments. As a result, Columbia made adjustments to its distribution statements for the specific film.
In 1983, Sidney Finger performed an audit of Columbia's records with respect to the four films. In 1985, he completed another audit. As a result of the two audits, $ 3,584,005 *83 of additional claims (in addition to a "Bite the Bullet" breach of warranty claim) were asserted by Vista against Columbia. As of the time of trial, no final resolution of these disputes had yet been achieved.
Vista retained the service of Margold, Ersken & Wang and, later, Frank, Zimmerman & Co., P.C., to prepare annual financial statements for Vista.
During the years 1974 through 1984, Vista incurred and paid the following amounts of management fees, professional fees, and administrative, travel and entertainment, and sundry expenses: *586 Admininistrative,
travel,
Year Management Professional and sundry
1974 $ 582,936 $ 44,841 $ 90
1975 652,350 4,933 427,648
1976 0 20,403 337,061
1977 0 5,381 37,634
1978 0 6,278 14,995
1979 0 1,569 6,507
1980 0 3,840 5,511
1981 0 1,704 6,988
1982 0 7,864 12,821
1983 0 21,092 11,201
1984 0 44,101 1,674
The parties stipulated that if the Court determines that Vista was engaged in an activity for profit, the management fees shall be treated as follows: $ 247,057 shall be treated as nondeductible, nonamortizable syndication expenses, $ 247,057 shall be treated as ordinary and necessary *84 expenses fully deductible in 1974, $ 92,646 shall be added to the partnership's basis for each of the four films (a total of $ 370,584), and $ 370,586 shall be capitalized and amortized annually in equal amounts over 10 years, beginning in 1974. The parties also stipulated that if the Court determines that Vista was engaged in an activity for profit, the other listed expenses would be deductible in the years paid.
Vista kept its books and filed its partnership returns employing the cash receipts and disbursements method of accounting. For taxable years 1974 through 1984, Vista reported the amounts and expenses shown on page 603 as attributable to the four films.
Vista is entitled to employ the income-forecast method of computing depreciation with respect to the four films in question. On its partnership tax returns, Vista employed the income-forecast method. Vista requested from Columbia estimates of Columbia's total gross receipts, releasing costs, motion picture association dues, and taxes for each film. Columbia included in its estimates for "Breakout" estimated television gross receipts and releasing costs. Vista used Columbia's estimates with several modifications to calculate *85 depreciation for each film. 12 Vista calculated net *587 Funny Lady
1975
I. Gross receipts
United States:
Theatrical $ 14,447,608
Nontheatrical and trailer 72,101
Network television 0
Pay television 5 $ 14,519,714
Foreign 2,245,014
Soundtrack royalties 500,000
Merchandising 50,000
Total gross receipts 17,314,728
II. Expenses before debt service
Distribution fees 5,541,468
Releasing costs 3,287,316
Motion Picture Association dues and taxes 264,057
Third-party gross participations 2,345,102
Total 11,437,943
Distributable gross receipts 5,876,785
III. Promissory note payments
Principal 4,132,938
Interest 274,651 4,407,589
Net after debt service 1,469,196
Funny Lady
1976
I. Gross receipts
United States:
Theatrical $ 3,724,448
Nontheatrical and trailer 335,401
Network television 0
Pay television 0 $ 4,059,849
Foreign 1,219,561
Soundtrack royalties (166,667)
Merchandising 0
Total gross receipts 5,112,743
II. Expenses before debt service
Distribution fees 1,644,889
Releasing costs 1,208,311
Motion Picture Association dues and taxes 31,962
Third-party gross participations (1,163,143)
Total 1,722,019
Distributable gross receipts 3,390,724
III. Promissory note payments
Principal 2,371,633
Interest 171,460 2,543,093
Net after debt service 847,631
*86 Funny Lady
1977
I. Gross receipts
United States:
Theatrical $ 167,390
Nontheatrical and trailer 113,136
Network television 0
Pay television 504,512 $ 785,038
Foreign 292,519
Soundtrack royalties (107,107)
Merchandising 0
Total gross receipts 970,450
II. Expenses before debt service
Distribution fees 304,127
Releasing costs 300,185
Motion Picture Association dues and taxes (5,640)
Third-party gross participations 121,096
Total 719,768
Distributable gross receipts 250,682
III. Promissory note payments
Principal 0
Interest 188,012 188,012
Net after debt service 62,670
Funny Lady
1978
I. Gross receipts
United States:
Theatrical $ 72,891
Nontheatrical and trailer 14,694
Network television 0
Pay television 50,125 $ 137,710
Foreign 178,178
Soundtrack royalties 0
Merchandising 10,000
Total gross receipts 325,888
II. Expenses before debt service
Distribution fees 99,522
Releasing costs 104,633
Motion Picture Association dues and taxes 5,071
Third-party gross participations 61,139
Total 270,365
Distributable gross receipts 55,523
III. Promissory note payments
Principal 0
Interest 41,642 41,642
Net after debt service 13,881
*87 *588 Funny Lady
1979
I. Gross receipts
United States:
Theatrical ($ 3,319)
Nontheatrical and trailer 45,051
Network television 0
Pay television 51,222 $ 92,954
Foreign 63,895
Soundtrack royalties 0
Merchandising 0
Total gross receipts 156,849
II. Expenses before debt service
Distribution fees 49,853
Releasing costs 37,965
Motion Picture Association dues and taxes 2,065
Third-party gross participations 46,837
Total 136,720
Distributable gross receipts 20,129
III. Promissory note payments
Principal 0
Interest 15,097 15,097
Net after debt service 5,032
Funny Lady
1980
I. Gross receipts
United States:
Theatrical $ 2,410
Nontheatrical and trailer 45,013
Network television 0
Pay television 162,286 $ 209,709
Foreign 846,006
Soundtrack royalties 0
Merchandising 0
Total gross receipts 1,055,715
II. Expenses before debt service
Distribution fees 334,231
Releasing costs 138,850
Motion Picture Association dues and taxes 26,636
Third-party gross participations 482,165
Total 981,882
Distributable gross receipt 73,833
III. Promissory note payments
Principal 0
Interest 55,374 55,374
Net after debt service 18,459
*88 Funny Lady
1981
I. Gross receipts
United States:
Theatrical $ 13,243
Nontheatrical and trailer 160
Network television 1,625,000
Pay television 18,289 $ 1,656,692
Foreign 68,194
Soundtrack royalties 0
Merchandising 0
Total gross receipts 1,724,886
II. Expenses before debt service
Distribution fees 558,875
Releasing costs 29,893
Motion Picture Association dues and taxes 4,150
Third-party gross participations 1,118,819
Total 1,711,737
Distributable gross receipts 13,149
III. Promissory note payments
Principal 0
Interest 11,417 11,417
Net after debt service 1,732
Funny Lady
1982
I. Gross receipts
United States:
Theatrical ($ 4,912)
Nontheatrical and trailer (33,529)
Network television 625,000
Pay television 0 $ 586,559
Foreign 67,425
Soundtrack royalties 0
Merchandising 0
Total gross receipts 653,984
II. Expenses before debt service
Distribution fees 212,050
Releasing costs 71,173
Motion Picture Association dues and taxes 3,670
Third-party gross participations 318,204
Total 605,097
Distributable gross receipts 48,887
III. Promissory note payments
Principal 0
Interest 35,110 35,110
Net after debt service 13,777
*89 *589 Funny Lady
1983
I. Gross receipts
United States:
Theatrical $ 399
Nontheatrical and trailer 1,863
Network television 0
Pay television 3,132 $ 5,394
Foreign 103,405
Soundtrack royalties 18,774
Merchandising 0
Total gross receipts 127,573
II. Expenses before debt service
Distribution fees 40,274
Releasing costs 49,992
Motion Picture Association dues and taxes 17,606
Third-party gross participaations 5,683
Total 113,485
Distributable gross receipts 14,088
III. Promissory note payments
Principal 0
Interest 10,565 10,565
Net after debt service 3,523
Funny Lady
1984
I. Gross receipts
United States:
Theatrical $ 636
Nontheatrical and trailer 1,205
Network television 250,000
Pay television 0 $ 251,841
Foreign 52,604
Soundtrack royalties 831
Merchandising 0
Total gross receipts 305,276
II. Expenses before debt service
Distribution fees 78,006
Releasing costs 0
Motion Picture Association dues and taxes 64,754
Third-party gross participations 162,523
Total 305,283
Distributable gross receipts (7)
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service (7)
*90 *590 Funny Lady
I. Gross receipts Cumulative (1975-1984)
United States:
Theatrical $ 18,420,794
Nontheatrical and trailer 595,095
Network television 2,500,000
Pay television 789,571 $ 22,305,460
Foreign 5,136,801
Soundtrack royalties 245,831
Merchandising 60,000
Total gross receipts 27,748,092
II. Expenses before debt service
Distribution fees 8,863,295
Releasing costs 5,228,248
Motion Picture Association dues and taxes 414,331
Third-party gross participations 3,498,425
Total 18,004,299
Distributable gross receipts 9,743,793
III. Promissory note payments
Principal 6,504,571
Interest 1 803,328 7,307,899
Net after debt service 2,435,894
*591 Breakout
1975
I. Gross receipts
United States:
Theatrical $ 5,892,613
Non-theatrical and trailer 150,560
Network television 0
Pay television 20,137
Television syndication 0 $ 6,063,310
Foreign 4,543,684
Video cassette 0
Video disc (RCA) 0
Total gross receipts 10,606,994
II. Expenses before debt service
Distribution fees 3,358,568
Releasing costs 3,124,045
Motion Picture Association dues and taxes 269,995
Third-party deferments 0
Total 6,752,608
Distributable gross receipts 3,854,386
III. Promissory note payments
Principal 2,730,462
Interest 160,327 2,890,789
Net after debt service 963,597
*91 Breakout
1976
I. Gross receipts
United States:
Theatrical $ 815,000
Non-theatrical and trailer 295,711
Network television 0
Pay television 134,549
Television syndication 0 $ 1,245,260
Foreign 1,586,889
Video cassette 0
Video disc (RCA) 0
Total gross receipts 2,832,149
II. Expenses before debt service
Distribution fees 874,823
Releasing costs 559,034
Motion Picture Association dues and taxes 87,501
Third-party deferments 25,000
Total 1,546,791
Distributable gross receipts 1,285,791
III. Promissory note payments
Principal 785,200
Interest 179,143 964,343
Net after debt service 321,448
Breakout
1977
I. Gross receipts
United States:
Theatrical $ 88,367
Non-theatrical and trailer 68,798
Network television 1,275,000
Pay television 80,077
Television syndication 0 $ 1,512,242
Foreign 718,726
Video cassette 0
Video disc (RCA) 0
Total gross receipts 2,230,968
II. Expenses before debt service
Distribution fees 707,578
Releasing costs 895,101
Motion Picture Association dues and taxes 26,388
Third-party deferments 25,000
Total 1,654,067
Distributable gross receipts 576,901
III. Promissory note payments
Principal 222,813
Interest 209,863 432,676
Net after debt service 144,225
*92 Breakout
1978
I. Gross receipts
United States:
Theatrical $ 21,526
Non-theatrical and trailer 55,755
Network television 225,000
Pay television 175
Television syndication 0 $ 302,456
Foreign 384,447
Video cassette 0
Video disc (RCA) 0
Total gross receipts 686,903
II. Expenses before debt service
Distribution fees 192,513
Releasing costs 290,168
Motion Picture Association dues and taxes 19,407
Third-party deferments 0
Total 502,088
Distributable gross receipts 184,815
III. Promissory note payments
Principal 0
Interest 138,611 138,611
Net after debt service 46,204
*592 Breakout
1979
I. Gross receipts
United States:
Theatrical $ 6,457
Nontheatrical and trailer 21,247
Network television 0
Pay television 1
Television syndication 0 $ 27,705
Foreign 249,677
Video cassette 0
Video disc (RCA) 0
Total gross receipts 277,382
II. Expenses before debt service
Distribution fees 89,409
Releasing costs 106,265
Motion Picture Association dues and taxes 11,386
Third-party deferments 0
Total 207,060
Distributable gross receipts 70,322
III. Promissory note payments
Principal 0
Interest 52,742 52,742
Net after debt service 17,580
*93 Breakout
1980
I. Gross receipts
United States:
Theatrical ($ 345)
Nontheatrical and trailer 24,088
Network television 0
Pay television 91,869
Television syndication 16,296 $ 131,908
Foreign 279,199
Video cassette 254,288
Video disc (RCA) 0
Total gross receipts 665,395
II. Expenses before debt service
Distribution fees 218,793
Releasing costs 259,091
Motion Picture Association dues and taxes 18,206
Third-party deferments 0
Total 496,090
Distributable gross receipts 169,305
III. Promissory note payments
Principal 0
Interest 126,575 126,575
Net after debt service 42,730
Breakout
1981
I. Gross receipts
United States:
Theatrical $ 4,520
Nontheatrical and trailer 15,096
Network television 0
Pay television 921
Television syndication 120,663 $ 141,200
Foreign 396,368
Video cassette 62,913
Video disc (RCA) 0
Total gross receipts 600,481
II. Expenses before debt service
Distribution fees 188,457
Releasing costs 228,143
Motion Picture Association dues and taxes 34,549
Third-party deferments 0
Total 451,149
Distributable gross receipts 149,332
III. Promissory note payments
Principal 0
Interest 111,999 111,999
Net after debt service 37,333
*94 Breakout
1982
I. Gross receipts
United States:
Theatrical ($ 2,122)
Nontheatrical and trailer 4,432
Network television 0
Pay television 0
Television syndication 209,973 $ 212,283
Foreign 150,534
Video cassette 32,803
Video disc (RCA) 0
Total gross receipts 425,620
II. Expenses before debt service
Distribution fees 128,703
Releasing costs 169,111
Motion Picture Assocition dues and taxes 13,725
Third-party deferments 0
Total 311,539
Distributable gross receipts 114,081
III. Promissory note payments
Principal 0
Interest 85,561 85,561
Net after debt service 28,520
*593 Breakout
1983
I. Gross receipts
United States:
Theatrical $ 150
Non-theatrical and trailer 8,475
Network television 0
Pay television 0
Television syndication 209,009 $ 217,634
Foreign 82,119
Video cassette 5,494
Video disc (RCA) 200,565
Total gross receipts 505,812
II. Expenses before debt service
Distribution fees 163,549
Releasing costs 164,257
Motion Picture Association dues and taxes 66,767
Third-party deferments 0
Total 394,573
Distributable gross receipts 111,239
III. Promissory note payments
Principal 0
Interest 83,430 83,430
Net after debt service 27,809
*95 Breakout
1984
I. Gross receipts
United States:
Theatrical $ 442
Non-theatrical and trailer 1,759
Network television 0
Pay television 0
Television syndication 174,641 $ 176,842
Foreign 38,624
Video cassette 14,093
Video disc (RCA) 114,069
Total gross receipts 343,628
II. Expenses before debt service
Distribution fees 2,512
Releasing costs 192,377
Motion Picture Association dues and taxes 14,987
Third-party deferments 0
Total 209,876
Distributable gross receipts 133,752
III. Promissory note payments
Principal 0
Interest 100,314 100,314
Net after debt service 33,438
*594 Breakout
Cumulative (1975-1984)
I. Gross receipts
United States:
Theatrical $ 6,826,608
Nontheatrical and trailer 645,921
Network television 1,500,000
Pay television 327,729
Television syndication 730,582 $ 10,030,840
Foreign 8,430,267
Video cassette 369,591
Video disc (RCA) 344,634
Total gross receipts 19,175,332
II. Expenses before debt service
Distribution fees 5,924,905
Releasing costs 5,987,592
Motion Picture Association dues and taxes 562,911
Third-party deferments 50,000
Total 12,525,408
Distributable gross receipts 6,649,924
III. Promissory note payments
Principal 3,738,475
Interest 1 1,248,565 4,987,040
Net after debt service 1,662,884
*96
*595 Shampoo
1975
I. Gross receipts
United States:
Theatrical $ 16,244,373
Nontheatrical and trailer 37,097
Network television 0
Pay television 31,279
Television syndication 0 $ 16,312,749
Foreign 2,252,337
Total gross receipts 18,565,086
II. Expenses before debt service
Distribution fees 6,048,891
Releasing costs 3,827,985
Motion Picture Association dues and taxes 300,464
Third-party gross participations 1,551,900
Third-party net participations 689,000
Total 12,418,240
Distributable gross receipts 6,146,846
III. Promissory note payments
Principal 4,691,839
Interest (81,704) 4,610,135
Net after debt service 1,536,711
Shampoo
1976
I. Gross receipts
United States:
Theatrical $ 5,090,517
Nontheatrical and trailer 63,479
Network television 0
Pay television 76,406
Television syndication 0 $ 5,230,402
Foreign 2,854,374
Total gross receipts 8,084,776
II. Expenses before debt service
Distribution fees 2,787,495
Releasing costs 1,078,264
Motion Picture Association dues and taxes 110,460
Third-party gross participations 793,984
Third-party net participations 1,048,126
Total 5,818,329
Distributable gross receipts 2,266,447
III. Promissory note payments
Principal 708,161
Inteest 81,704 789,865
Net after debt service 1,476,582
*97 Shampoo
1977
I. Gross receipts
United States:
Theatrical $ 557,402
Nontheatrical and trailer 77,295
Network television 0
Pay television 402,856
Television syndication 0 $ 1,037,553
Foreign 1,327,913
Total gross receipts 2,365,466
II. Expenses before debt service
Distribution fees 769,489
Releasing costs 676,650
Motion Picture Association dues and taxes 149,545
Third-party gross participations 375,663
Third-party net participations 315,964
Total 2,287,311
Distributable gross receipts 78,155
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 78,155
Shampoo
1978
I. Gross receipts
United States:
Theatrical $ 120,934
Nontheatrical and trailer 29,727
Network television 0
Pay television 61,640
Television syndication 0 $ 212,301
Foreign 251,113
Total gross receipts 463,414
II. Expenses before debt service
Distribution fees 151,003
Releasing costs 141,304
Motion Picture Association dues and taxes 22,415
Third-party gross participations 72,253
Third-party net participations 62,241
Total 449,216
Distributable gross receipts 14,198
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 14,198
*98 *596 Shampoo
1979
I. Gross receipts
United States:
Theatrical $ 101,705
Nontheatrical and trailer 27,184
Network television 1,787,500
Pay television 46,789
Television syndication 0 $ 1,963,178
Foreign 224,564
Total gross receipts 2,187,742
II. Expenses before debt service
Distribution fees 710,015
Releasing costs 688,624
Motion Picture Association dues and taxes 8,716
Third-party gross participations 382,379
Third-party net participations 374,546
Total 2,164,280
Distributable gross receipts 23,462
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 23,462
Shampoo
1980
I. Gross receipts
United States:
Theatrical ($ 17,899)
Nontheatrical and trailer 44,086
Network television 0
Pay television 754
Television syndication 0 $ 26,941
Foreign 222,388
Total gross receipts 249,329
II. Expenses before debt service
Distribution fees 76,049
Releasing costs 74,653
Motion Picture Association dues and taxes 18,335
Third-party gross participations 35,441
Third-party net participations 25,725
Total 230,203
Distributable gross receipts 19,126
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 19,126
*99 Shampoo
1981
I. Gross receipts
United States:
Theatrical $ 11,137
Nontheatrical and trailer 5,157
Network television 0
Pay television 5,777
Television syndication 0 $ 22,071
Foreign 392,833
Total gross receipts 414,904
II. Expenses before debt service
Distribution fees 125,833
Releasing costs 130,477
Motion Picture Assocition dues and taxes 14,188
Third-party gross participations 65,314
Third-party net participations 55,317
Total 391,129
Distributable gross receipts 23,775
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 23,775
Shampoo
1982
I. Gross receipts
United States:
Theatrical $ 8,791
Nontheatrical and trailer 17,071
Network television 687,500
Pay television 0
Television syndication 0 $ 713,362
Foreign 187,651
Total gross receipts 901,013
II. Expenses before debt service
Distribution fees 286,841
Releasing costs 280,408
Motion Picture Association dues and taxes 15,337
Third-party gross participations 144,147
Third-party net participations 141,223
Total 867,956
Distributable gross receipts 33,057
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 33,057
*100 *597 Shampoo
1983
I. Gross receipts
United States:
Theatrical $ 1,534
Nontheatrical and trailer 983
Network television 275,000
Pay television 2,884
Television syndication 635,062 $ 915,463
Foreign 101,835
Total gross receipts 1,017,298
II. Expenses before debt service
Distribution fees 328,241
Releasing costs 298,393
Motion Picture Association dues and taxes 42,466
Third-party gross participations 156,586
Third-party net participations 146,146
Total 971,832
Distributable gross receipts 45,466
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 45,466
Shampoo
1984
I. Gross receipts
United States:
Theatrical $ 376
Nontheatrical and trailer 1,502
Network television 0
Pay television 0
Television syndication 218,640 $ 220,518
Foreign 123,430
Total gross receipts 343,948
II. Expenses before debt service
Distribution fees 97,947
Releasing costs 111,994
Motion Picture Association dues and taxes 41,759
Third-party gross participations 19,098
Third-party net participations 19,098
Total 289,896
Distributable gross receipts 54,052
III. Promissory note payments
Principal 0
Interest 0 0
Net after debt service 54,052
*101 *598 Shampoo
I. Gross receipts Cumulative (1975-1984)
United States:
Theatrical $ 22,118,870
Non-theatrical and trailer 303,581
Network television 2,750,000
Pay television 628,385
Television syndication 853,702 $ 26,654,538
Foreign 7,938,438
Total gross receipts 34,592,976
II. Expenses before debt service
Distribution fees 11,381,804
Releasing costs 7,308,752
Motion Picture Association dues and taxes 723,685
Third-party gross participations 3,596,765
Third-party net participations 2,877,386
Total 25,888,392
Distributable gross receipts 8,704,584
III. Promissory note payments
Principal 5,400,000
Interest 1 0 5,400,000
Net after debt service 3,304,584
*599 Bite the Bullet
1975
I. Gross receipts
United States:
Theatrical $ 2,130,904
Nontheatrical and trailer 5,768
Network television 0
Pay television 0 $ 2,136,672
Foreign 358,244
Video cassette 0
Total gross receipts 2,494,916
II. Expenses before debt service
Distribution fees 792,123
Releasing costs 659,288
Motion Picture Association dues and taxes 57,615
Total 1,509,026
Distributable gross receipts 985,890
III. Promissory note payments
Principal 432,249
Interest 307,167 739,416
Net after debt service 246,474
*102 Bite the Bullet
1976
I. Gross receipts
United States:
Theatrical $ 2,530,124
Nontheatrical and trailer 393,250
Network television 0
Pay television 10,406 $ 2,933,780
Foreign 2,367,500
Video cassette 0
Total gross receipts 5,301,280
II. Expenses before debt service
Distribution fees 1,686,116
Releasing costs 1,388,562
Motion Picture Association dues and taxes 92,489
Total 3,167,167
Distributable gross receipts 2,134,113
III. Promissory note payments
Principal 1,332,863
Interest 267,722 1,600,585
Net after debt service 533,528
Bite the Bullet
1977
I. Gross receipts
United States:
Theatrical $ 136,172
Nontheatrical and trailer 172,492
Network television 0
Pay television 249,590 $ 558,254
Foreign 632,678
Video cassette 0
Total gross receipts 1,190,932
II. Expenses before debt service
Distribution fees 355,260
Releasing costs 488,963
Motion Picture Association dues and taxes 41,740
Total 885,963
Distributable gross receipts 304,969
III. Promissory note payments
Principal 0
Interest 228,727 228,727
Net after debt service 76,242
Bite the Bullet
1978
I. Gross receipts
United States:
Theatrical $ 39,088
Nontheatrical and trailer 19,429
Network television 877,500
Pay television 17,195 $ 953,212
Foreign 349,118
Video cassette 0
Total gross receipts 1,302,330
II. Expenses before debt service
Distribution fees 411,741
Releasing costs 555,577
Motion Picture Association dues and taxes 20,307
Total 987,625
Distributable gross receipts 314,705
III. Promissory note payments
Principal 0
Interest 236,029 236,029
Net after debt service 78,676
*103 *600 Bite the Bullet
1979
I. Gross receipts
United States:
Theatrical $ 17,623
Nontheatrical and trailer 31,379
Network television 0
Pay television 514 $ 49,516
Foreign 316,554
Video cassette 0
Total gross receipts 366,070
II. Expenses before debt service
Distribution fees 112,161
Releasing costs 156,731
Motion Picture Association dues and taxes 7,545
Total 276,437
Distributable gross receipts 89,633
III. Promissory note payments
Principal 0
Interest 67,225 67,225
Net after debt service 22,048
Bite the Bullet
1980
I. Gross receipts
United States:
Theatrical $ 3,214
Nontheatrical and trailer 5,254
Network television 337,500
Pay television 271 $ 346,239
Foreign 271,062
Video cassette 0
Total gross receipts 617,301
II. Expenses before debt service
Distribution fees 192,575
Releasing costs 252,796
Motion Picture Association dues and taxes 22,127
Total 467,498
Distributable gross receipts 149,803
III. Promissory note payments
Principal 0
Interest 112,353 112,353
Net after debt service 37,450
Bite the Bullet
1981
I. Gross receipts
United States:
Theatrical $ 3,879
Nontheatrical and trailer 3,497
Network television 135,000
Pay television 40,000 $ 182,376
Foreign 295,406
Video cassette 0
Total gross receipts 477,782
II. Expenses before debt service
Distribution fees 145,736
Releasing costs 189,974
Motion Picture Association dues and taxes 24,597
Total 360,307
Distributable gross receipts 117,475
III. Promissory note payments
Principal 0
Interest 88,106 88,106
Net after debt sevice 29,369
*104 Bite the Bullet
1982
I. Gross receipts
United States:
Theatrical ($ 418)
Nontheatrical and trailer 2,914
Network television 0
Pay television 20,584 $ 23,080
Foreign 66,025
Video cassette 0
Total gross receipts 89,105
II. Expenses before debt service
Distribution fees 26,021
Releasing costs 34,730
Motion Picture Association dues and taxes 6,527
Total 67,278
Distributable gross receipts 21,828
III. Promissory note payments
Principal 0
Interest 16,370 16,370
Net after debt service 5,458
*601 Bite the Bullet
1983
I. Gross receipts
United States:
Theatrical $ 225
Nontheatrical and trailer 2,067
Network television 0
Pay television 46,273 $ 48,565
Foreign 31,225
Video cassette 0
Total gross receipts 79,790
II. Expenses before debt service
Distribution fees 20,759
Releasing costs 25,118
Motion Picture Association dues and taxes 18,592
Total 64,469
Distributable gross receipts 15,321
III. Promissory note payments
Principal 0
Interest 11,378 11,378
Net after debt service 3,943
Bite the Bullet
1984
I. Gross receipts
United States:
Theatrical ($ 131)
Nontheatrical and trailer 5,504
Network television 0
Pay television 436 $ 5,809
Foreign 91,961
Video cassette 106,863
Total gross receipts 204,633
II. Expenses before debt service
Distribution fees 33,464
Releasing costs 89,424
Motion Picture Association dues and taxes 24,694
Total 147,582
Distributable gross receipts 57,051
III. Promissory note payments
Principal 0
Interest 42,788 42,788
Net after debt service 14,263
*105 *602 Bite the Bullet
I. Gross receipts Cumulative (1975-1984)
United States:
Theatrical $ 4,860,680
Nontheatrical and trailer 641,554
Network television 1,350,000
Pay television 385,269 $ 7,237,503
Foreign 4,779,773
Video cassette 106,863
Total gross receipts 12,124,139
II. Expenses before debt service
Distribution fees 3,775,956
Releasing costs 3,841,163
Motion Picture Association dues and taxes 316,233
Total 7,933,352
Distributable gross receipts 4,190,787
III. Promissory note payments
Principal 1,765,112
Interest 1 1,377,865 3,142,977
Net after debt service 1,047,810
*603 Payments
Year Income to partners Interest
1974 0 $ 582,936 $ 2,825,000
1975 $ 48,991,604 652,350 660,441
1976 21,331,867 0 702,451
1977 6,765,501 0 626,602
1978 2,783,230 0 416,282
1979 2,994,422 0 135,063
1980 2,602,442 0 294,302
1981 3,218,053 0 211,522
1982 2,095,381 0 137,041
1983 1,741,764 0 105,373
1984 1,210,013 0 143,102
Total 93,734,277 1,235,286 6,257,179
Other Income/
Year Depreciation expenses 1 (loss)
1974 0 $ 44,931 ($ 3,452,867)
1975 $ 17,048,000 32,550,398 (1,919,585)
1976 6,386,506 2 12,592,911 1,649,999
1977 1,274,528 5,590,125 (725,754)
1978 670,675 2,230,567 (534,294)
1979 552,838 2,792,575 (486,054)
1980 856,716 2,185,025 (733,601)
1981 907,213 2,923,015 (823,697)
1982 445,428 1,872,555 (359,643)
1983 229,530 1,576,652 (169,791)
1984 256,911 998,412 (188,412)
Total 28,628,345 65,357,166 (7,743,699)
*106
*604 receipts by subtracting from gross receipts estimated distribution fees, releasing costs, motion picture association dues, and taxes. Vista did not include third-party participations in its calculations. In each subsequent year, Vista determined that there were circumstances which required that the estimates be revised, and adjusted these estimates accordingly.
In 1974, petitioners made *107 capital contributions to Vista in the following amounts: Petitioner Amounts
Guy B. Bailey, Jr $ 53,333.33
Henry Milgram 80,000.00
William Milgram 80,000.00
Norman B. Levy 40,000.00
During the years in issue, petitioners held interests in the profits, losses, and investment tax credits of Vista as follows: Petitioner Years Interest
Guy B. Bailey, Jr. 1974-76 0.6533%
Henry Milgram 1974-79 0.98
William Milgram 1974-80 0.98
Norman B. Levy 1974-78 0.49
During the years in issue, the limited partners of Vista held in aggregate a 95.06-percent interest in the profits, losses, and investment tax credits in Vista.
For the years 1974 through 1984, Vista made cash distributions to its partners as follows: Year Amount distributed
1974 0
1975 $ 3,844,999
1976 2,825,001
1977 380,000
1978 162,000
1979 73,000
1980 58,001
1981 140,000
1982 150,000
1983 140,000
1984 40,000
Total 7,813,001
On their Federal income tax returns, petitioners reported the following amounts as their distributive shares of the income or loss from Vista (for all five films): *605 Partner Year Income (loss)
Guy B. Bailey, Jr. 1974 ($ 36,684)
1975 (13,430)
1976 17,448
Henry Milgram 1974 (55,053)
1975 (20,147)
1976 26,175
1977 (1,608)
1978 (4,920)
1979 (4,630)
William Milgram 1974 (55,053)
1975 (20,146)
1976 26,175
1977 (1,608)
1978 (4,920)
1979 (4,625)
1980 (7,173)
Norman B. Levy 1974 (27,527)
1975 (10,073)
1976 13,088
*108 On their 1975 Federal income tax returns, petitioners claimed the following amounts of investment tax credit with respect to property placed in service by Vista: Partner Amount
Guy B. Bailey, Jr $ 12,280
Henry Milgram 19,894
William Milgram 19,894
Norman B. Levy 9,947
The 7-percent investment-tax credit was based on each partner's distributive share of Vista's $ 29 million purchase price for the four films.
Each Vista film constitutes a qualified film within the meaning of section 48(k)(1)(B) . Each of the films constituted new section 38 property (determined without regard to useful life) as to Vista within the meaning of section 48(k)(1)(A)(i) when Vista placed the films in service in 1975.
OPINION
These consolidated cases involve a number of issues arising from petitioner-husbands' interests as limited partners in Persky-Bright and Vista, two partnerships of which Lester Persky and Richard S. Bright are directly or *606 indirectly the general partners. It is anticipated that the Court's opinion will provide guidance as to how to resolve the issues in various other partnerships in which Persky and Bright are directly or indirectly general partners.
Respondent's *109 determinations set forth various grounds for disallowing the deductions and investment tax credits claimed by petitioner-husbands as limited partners in Persky-Bright and Vista.
The initial issue for determination is whether Persky-Bright and Vista became the owners of the relevant motion pictures. As we have found, and as petitioners have conceded, the transactions under review were between Columbia and the partnerships, and we see no need for any further reference to the nominal ownership by the other entities.
Petitioners' initial contention is that the purchase of the motion pictures by the partnerships should be recognized for Federal tax purposes. They argue that the partnerships' purchases of the motion pictures were motivated by a business purpose and supported by economic substance, and that the partnerships acquired the benefits and burdens of ownership and an equity interest in the motion pictures.
Respondent's initial contention is that the partnerships' ownership of the motion pictures should be disregarded for Federal income tax purposes. Respondent argues that Columbia retained possession and control of the films through the distribution agreements, that the partnerships *110 never acquired an equity interest in the films, and that the partnerships never acquired the burden and benefits of ownership of the films.
At the Court's direction, each of the parties filed supplemental briefs with respect to the applicability to these cases of the opinions in Durkin v. Commissioner , 87 T.C. 1329 (1986) , Tolwinsky v. Commissioner , 86 T.C. 1009 (1986) , and Law v. Commissioner , 86 T.C. 1065 (1986) .
Whether the partnerships became the owners of the motion pictures for tax purposes as a result of the transactions involved herein are questions of fact to be determined by reference to the written agreements read in light of the attending facts and circumstances. Grodt & McKay Realty, Inc. v. Commissioner , 77 T.C. 1221 , 1237 *607 (1981) ; Miller v. Commissioner , 68 T.C. 767 , 776 (1977) ; see Fields v. Commissioner , 14 T.C. 1202 , 1210-1213 (1950) , affd. 189 F.2d 950 (2d Cir. 1951) . It is well established that the economic substance of a transaction rather *111 than the form in which it is cast is determinative of its tax consequences. See Golsen v. Commissioner , 54 T.C. 742 , 754 (1970) , affd. 445 F.2d 985 (10th Cir. 1971) , and the cases cited therein.
For purposes of Federal income taxation, a sale occurs upon the transfer of the benefits and burdens of ownership rather than upon the satisfaction of the technical requirements for the passage of title under State law. Grodt & McKay Realty, Inc. v. Commissioner, supra . In a number of cases, this Court and other courts have refused to permit the transfer of formal legal title to shift the incidence of taxation attributable to ownership of the property where the transferor continues to retain significant control over the property transferred. E.g., Helvering v. Clifford , 309 U.S. 331 (1940) ; Helvering v. F&R Lazarus Co ., 308 U.S. 252 (1939) ; Durkin v. Commissioner , 87 T.C. 1329 (1986) ; Tolwinsky v. Commissioner , 86 T.C. 1009 (1986) ; Hilton v. Commissioner , 74 T.C. 305 (1980) , *112 affd. 671 F.2d 316 (9th Cir. 1982) . "Taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed -- the actual benefit for which the tax is paid." Corliss v. Bowers , 281 U.S. 376 , 378 (1930) . It is therefore fundamental that the availability of a depreciation deduction is not predicated on the mere holding of legal title to property but rather upon a capital investment in the property. Gladding Dry Goods Co. v. Commissioner , 2 B.T.A. 336 (1925) .
For tax purposes, a sale of a motion picture occurs when there is a transfer of all substantial rights of value in the motion picture copyright. Tolwinsky v. Commissioner , 86 T.C. at 1042-1043 . No sale occurs if the transferor retains substantial proprietary rights in the motion picture. Durkin v. Commissioner , 87 T.C. at 1369 ; see Carnegie Productions, Inc. v. Commissioner , 59 T.C. 642 , 653 (1973) ; Cory v. Commissioner , 23 T.C. 775 (1955) , affd. 230 F.2d 941 (2d Cir. 1956) . *113
*608 After a thorough review of the record, we find that Persky-Bright and Vista did not acquire depreciable interests in the motion pictures but, in substance, purchased intangible contractual rights to payments contingent upon the success of Columbia's exploitation of the motion pictures. Durkin v. Commissioner, supra ; Tolwinsky v. Commissioner, supra ; Law v. Commissioner, supra . The fact that the Persky-Bright and Vista purchase agreements used the language of a sale and purported to convey ownership is not determinative of whether each of the partnerships actually became the owner for purposes of depreciation. Helvering v. F&R Lazarus Co., supra ; Green v. Commissioner , 83 T.C. 667 (1984) .
An examination of the various written agreements and surrounding circumstances in these cases reveals that the partnerships acquired no substantial ownership rights in the motion pictures. We believe the instant cases are controlled by Durkin v. Commissioner , 87 T.C. 1329 (1987) , and Tolwinsky v. Commissioner , 86 T.C. 1009 (1986) . *114 As in those cases, the purchase agreements provide that the partnerships were acquiring legal title to the negative and the copyright of each film. Similarly, the distribution agreements grant back to Columbia the exclusive right to distribute and otherwise deal with the motion pictures throughout the world in all media under the terms of those agreements. Columbia also was given a security interest in each film's negative and copyright, which was filed with the proper recording office. Between the distribution agreement and its security interests, Columbia regained virtually every right it ostensibly transferred to the partnerships under the purchase agreements. Since we have integrated purchase and distribution agreements, it may be more realistic to say that Columbia retained all those rights.
Under the distribution agreements and related documents, Columbia had the right to obtain copies of the motion pictures, to sell or lease copies of the motion pictures, to show the motion pictures to the public, to promote and advertise the motion pictures, and, for the Vista films, to sell or license trailers, souvenir programs, and booklets. Columbia also had merchandising, publication, *115 and soundtrack record album rights and other subsidiary rights. *609 Columbia's distribution rights extended to other media including pay television, video cassettes, video discs, and commercial television. Columbia had the right to distribute the motion pictures through subdistributors or to make an outright sale or license of the theatrical distribution rights for a flat sum to a third party. 13 Such enumerated rights meant that Columbia had the entire bundle of rights that is a copyright. See Durkin v. Commissioner , 87 T.C. at 1369 .
Our conclusion that Columbia did not convey all substantial rights in the motion pictures and their copyrights is further supported by the fact that Columbia retained rights and liabilities commonly associated with ownership. Columbia had the right to *116 determine the overall sales and advertising policy in connection with the distribution of the motion pictures. Columbia's name was to appear on all the motion pictures and related advertising. Lastly, there is no credible evidence that the partnerships had any control over exploitation of the motion pictures. See Durkin v. Commissioner , 87 T.C. at 1369 -1370 .
Petitioners' claim that the partnerships through Persky were involved in the distribution strategy of the films is based on the self-serving testimony of Persky. We are satisfied that Persky was in frequent contact with Columbia's distribution staff, on behalf of the partnerships, to keep track of the distribution results as they impacted on the partnerships. We also are satisfied that Persky was not involved in any substantial way in Columbia's distribution strategy for these films or in any other matters involving Columbia's exploitation of these films.
Petitioners contend that they are the true owners of the motion pictures because they had the right under the distribution agreements to approve Columbia's sales and advertising policy in connection with the distribution of the films. Although *117 the agreements gave the partnerships the right to approve Columbia's sales and advertising policy, the agreements also provided that such approval shall not be unreasonably withheld. Marcus, who negotiated the agreements for Columbia, explained that this provision only *610 required Columbia to consult with the partnerships and that Columbia had the final say consistent with the normal practice of a major motion picture distributor. It is clear that Columbia ran its distribution program and any related advertising program. When Persky attempted to tell the Columbia distribution and marketing people what to do, they complained to Marcus about these disruptions to their operations. Marcus pressed Persky to promise not to contact such persons directly but to get any information Persky wanted from Marcus or through his office. Although we found that Warren Beatty and Persky prepared a series of ads for "Shampoo, this does not mean that Columbia relinquished control over its advertising policy, even for that motion picture.
Petitioners assert that Columbia was not permitted to sue for copyright infringement in its own name since the partnerships had the films registered with *118 the copyright office. This statement appears incorrect with respect to Columbia's rights at least for all the Vista films. The definition of gross receipts in the Vista distribution agreements contained in Exhibit A includes the net moneys received by Columbia from "recovery by Columbia for infringement of copyright of the Picture." Implicit in these provisions is legal action by Columbia to recover for infringement of the copyright of films owned by Columbia. This is yet another factor previously referred to as showing a lack of ownership by the purported purchasers. Durkin v. Commissioner, supra . The definition of gross receipts in the Persky-Bright distribution agreement merely incorporates the definition in Columbia's standard distribution agreement. Since the parties failed to include a copy of Columbia's standard distribution agreement in this voluminous record, we are unable to address this point as to the Persky-Bright film.
Although Columbia purported to convey ownership of the motion pictures and the copyrights thereto to the partnerships, Columbia retained complete and exclusive control over the motion pictures, effectively in perpetuity, *119 through the distribution agreements. It was clear from this record that the anticipated economic useful life of a film released during the 1973 through 1975 period was approximately 10 *611 years. Under the distribution agreements, the partnerships granted Columbia the exclusive license to distribute and deal with the motion pictures throughout the world in all media for a term of 10 years.
As a practical matter, the rights granted to Columbia pursuant to the distribution agreements were perpetual. The agreements expressly provided that Columbia has the right to extend the term and acquire the rights to distribute the motion pictures in perpetuity by paying the greater of the so-called fair market value of the extended distribution rights at the time the distribution rights were extended, or an amount of $ 25,000 ($ 15,000 for "Summer Wishes Winter Dreams" and "$ 40,000 for "Funny Lady"). That both Columbia and the partnerships intended to extend the distribution agreements in perpetuity is evident from the fact that the distribution agreements provide that fair market value for such extensions was to be based on the average price paid by Columbia to extend the term of the *120 agreements relating to the distribution of comparable pictures pursuant to which Columbia had acquired the distribution rights for a 10-year term and had exercised a right to extend the term in perpetuity. In short, all the parties agreed that Columbia would have the perpetual rights to distribution by payment of a modest sum or based on interrelated prices for comparable films which Columbia intended to keep under its control. Each of the Vista distribution agreements provided that the extension payments were to be deemed an advance by Columbia to the partnership and were to be recouped by Columbia out of Vista's share of the distributable gross receipts from the relevant film. A similar provision is contained in the Persky-Bright distribution agreement. Thus, the price for extension of a distribution agreement was an acceleration in the payment of distributable gross receipts otherwise to be paid to a partnership. Keeping in mind the fact that a major distributor was needed to engender distributable gross profits, we find that Columbia's rights under the distribution agreements were to be held in perpetuity.
Our conclusion that Columbia retained all substantial rights to the *121 motion pictures is further supported by the fact that Columbia retained a significant financial stake in *612 each motion picture and a significant financial interest in each motion picture and its proceeds. Tolwinsky v. Commissioner, supra ; Durkin v. Commissioner, supra . After receiving Persky-Bright's cash payments of $ 375,000 (including the amounts denominated as "prepaid interest"), Columbia remained at financial risk for $ 1,418,972 of the production costs for "Summer Wishes, Winter Dreams." After receiving Vista's cash payments of $ 5,650,000 (including the amounts denominated as "prepaid interest"), Columbia remained at financial risk for $ 18,833,180 of the production costs for the four films. For each of these films, Columbia's financial risks were significant and far outweighed those assumed by the partnerships. Columbia also held Persky-Bright's nonrecourse note of $ 1,850,000 and Vista's nonrecourse notes totaling $ 26,175,000. These notes were a measure of the funds from the films which could flow to Columbia aside from the distribution fees. Although there was a deferment of some releasing cost payments, *122 there was no limit placed on the amount of profit Columbia could receive from its distribution efforts. Columbia would not have sold the motion pictures if it could not distribute them. Columbia's financial interests combined with its exploitation of the films clearly indicate it had all the rights and responsibilities of ownership.
We disagree with petitioners' assertions that the partnerships were entitled to 100 percent of the distributable gross receipts from the films, subject to payment of the nonrecourse notes. Aside from the specified minimum gross receipts provisions, the essence of the agreements is that the partnerships are entitled to 25 percent of the distributable gross receipts from a particular film until the nonrecourse note pertaining to that film is paid from the other 75 percent. If a note is paid, then the partnership is entitled to 100 percent of the distributable gross receipts the film. In Durkin v. Commissioner, supra , one of the financial interests retained by the distributor was a substantial interest in the net proceeds after payment of the notes. See Vandenhoff v. Commissioner , T.C. Memo. 1987-116 . *123 From this, petitioners argue that the partnerships, which owned the negatives and copyrights, were owners of the motion pictures since they were entitled to *613 100 percent of the "net profits" if the notes were paid. This argument fails to consider the other ownership rights and financial interests retained by Columbia. In Tolwinsky v. Commissioner, supra , the partnerships likewise were entitled to 100 percent of the "net profits" if the notes were paid under comparable terms. The Court there characterized this right as an income interest "akin to, but not in fact a 'participation' in the profits of the motion picture's exploitation." Tolwinsky v Commissioner , 86 T.C. at 1050 . The Court also explained in that case that those payments would be made if the motion picture was wildly successful and that it was unlikely that the notes would be satisfied. In the instant cases, the partnerships likewise would receive 100 percent of the distributable gross receipts only if a film was wildly successful. At the time the agreements were executed, it was unlikely that the notes would be paid during the anticipated useful *124 life of 10 years. During the 10-year periods of the five notes held by the two partnerships, only the "Shampoo" note was satisfied and that was because "Shampoo" far exceeded the expectations of Columbia and Persky and was wildly successful. As in Durkin v. Commissioner, supra , and Tolwinsky v. Commissioner, supra , the partnerships here received an income interest in the exploitation of the motion pictures.
Moreover, our examination of the entire record leads us to conclude that Columbia merely sought to raise risk capital to offset approximately 20 percent of the production costs of its films. The total production cost of "Summer Wishes, Winter Dreams" was $ 1,939,822. Columbia raised risk capital in the amount of $ 375,000 through Persky-Bright. Consequently, Columbia offset more than 19 percent of the production cost. We do not believe that Columbia would relinquish ownership of that film for the guaranteed sum of $ 375,000 where production costs exceeded $ 1,900,000 and additional payment remained contingent and speculative. The total production costs of the four Vista films was $ 27,569,374. Columbia raised *125 risk capital in the amount of $ 5,650,000 through Vista. Consequently, Columbia offset approximately 20 percent of the production costs of those films. Again, we do not believe Columbia would relinquish ownership of those films for the guaranteed sum of *614 $ 5,650,000 where production costs exceeded $ 27,500,000 and additional payments remained contingent and speculative. 14 We are convinced that Columbia would not sell any of the films without retention of the substantial proprietary rights indicative of ownership.
The only interests acquired by the partnerships were a contingent participation in the *126 distributable gross receipts of Columbia's distribution efforts for each film. The cash investments by the partnerships reduced Columbia's financial risk in the films, but such payments, without more, do not give the partnerships depreciable interests in the film. Law v. Commissioner , 86 T.C. at 1097 ; See Vandenhoff v. Commissioner , T.C. Memo. 1987-116 . Because we have determined that Columbia was the actual owner of the films for Federal tax purposes, the partnerships obviously are not entitled to claim depreciation on the films. The partnerships are entitled to depreciate the intangible contractual rights to participate in the distributable gross receipts generated by the exploitation efforts of Columbia. Durkin v. Commissioner , 87 T.C. at 1372 -1373 ; Tolwinsky v. Commissioner , 86 T.C. at 1052-1053 ; Law v. Commissioner , 86 T.C. at 1098 .
The next issue for decision is whether the partnerships were activities not engaged in for profit so as to be subject to the limitations of section 183 . 15 Whether an activity is engaged *127 in for profit turns on whether the taxpayer has a bona fide objective of making a profit. Dreicer v. Commissioner , 78 T.C. 642 , 645 (1982) , affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983) ; Jasionowski v. Commissioner , 66 T.C. 312 , 321 (1976) . In determining whether the partnerships engaged in an activity for profit, "all the facts and circumstances with respect to the activity are to be taken into account." Sec. 1.183-2(b), Income Tax Regs. ; *615 Jasionowski v. Commissioner, supra ; Bessenyey v. Commissioner , 45 T.C. 261 , 274 (1965) , affd. 379 F.2d 252 (2d Cir. 1967) .
*128 In view of the factors set forth in Tolwinsky v. Commissioner , 86 T.C. at 1062-1063 , we find that Persky-Bright and Vista engaged in their motion picture activities with intent to make a profit. All five films at issue were of high quality and were made by people who were well known to the general public and respected in the film community. There was no doubt, at least with respect to the Vista films, that the investors knew at the time the purchase and distribution agreements were executed that the films would generate substantial amounts of gross receipts and that a portion of those receipts might ultimately be distributed to the limited partners. Finally, the partnerships could be assured of a well-financed and professional distribution effort by Columbia which would maximize the partnerships' share of gross receipts.
We turn to the issues of whether the nonrecourse purchase money notes are includable in basis, whether the interest on those notes is deductible, and whether the basis for the partnerships' contract rights is limited to the cost outlay with respect to each film.
Petitioners argue that the purchase money notes were given for business *129 reasons and should be included in the depreciable bases of their contract rights. However, when a transaction is so structured that payment by the taxpayer is not probable, either because of the length or the terms of the debt, the source of the payments, or any other arrangement which does not provide an economic incentive for the taxpayer to pay the debt, then such debt is not genuine indebtedness to be taken into account for purposes of determining a taxpayer's investment in property. See Tolwinsky v. Commissioner , 86 T.C. at 1048-1050 . Such a debt does not reflect an actual investment in property and cannot be included in the taxpayer's depreciable basis. Siegel v. Commissioner , 78 T.C. 659 , 684-691 (1982) ; Brannen v. Commissioner , 78 T.C. 471 (1982) , affd. 722 F.2d 695 (11th Cir. 1984) ; Estate of Franklin v. Commissioner , 64 T.C. 752 (1975) , affd. 544 F.2d 1045 (9th Cir. 1976) .
*616 Thus, when debt principal is payable solely out of exploitation proceeds, nonrecourse loans are contingent obligations *130 and are not treated as true debt. Durkin v. Commissioner , 87 T.C. at 1376 ; Estate of Baron v. Commissioner , 83 T.C. 542 , 550-553 (1984) , affd. 798 F.2d 65 (2d Cir. 1986) ; Fox v. Commissioner , 80 T.C. 972 , 1022-1023 (1983) , affd. without published opinion 742 F.2d 1441 (2d Cir. 1984) , affd. without published opinion sub nom. Hook v. Commissioner, Kratsa v. Commissioner, Leffel v. Commissioner, Rosenblatt v. Commissioner, Zemel v. Commissioner , 734 F.2d 5 -7, 9 (3d Cir. 1984), affd. sub nom. Barnard v. Commissioner , 731 F.2d 230 (4th Cir. 1984) ; Saviano v. Commissioner , 80 T.C. 955 (1983) , affd. 765 F.2d 643 (7th Cir. 1985) . Under facts similar to the instant cases, this Court has concluded that such notes were without business purpose, were executed solely to gain tax benefits, and were to be disregarded for tax purposes. Durkin v. Commissioner , 87 T.C. at 1378 . See Goldstein v. Commissioner , 364 F.2d 734 , 740 (2d Cir. 1966) , *131 affg. 44 T.C. 284 (1965) ; see also Knetsch v. United States , 364 U.S. 361 (1960) .
As noted in Law , the instant cases are distinguishable from cases where respondent did not challenge the purchaser's ownership of the property acquired. Law v. Commissioner , 86 T.C. at 1100 n. 22 . See, e.g., Fuchs v. Commissioner , 83 T.C. 79 (1984) ; Siegel v. Commissioner , 78 T.C. 659 (1982) ; Brannen v. Commissioner , 78 T.C. 471 (1982) , affd. 722 F.2d 695 (11th Cir. 1984) . The instant cases are unlike Leahy v. Commissioner , 87 T.C. 56 (1986) , where the record indicated that the partnership in fact purchased a 25-percent joint-venture interest. Leahy v. Commissioner, supra . The instant cases also are distinguishable from Taube v. Commissioner , 88 T.C. 464 (1987) , where the out-of-pocket production costs were paid by the partner's contributions, where the notes representing deferred production costs *132 plus a profit were personally guaranteed to the seller by the assumption agreements signed by the limited partners, and where the seller would be paid the amount of the note even if the films never generated a single dollar of revenue.
Once we have looked through the form of the transactions in issue and have determined that the partnerships only had *617 an income interest in the exploitation receipts from the motion pictures, it necessarily follows that the purchase notes must be disregarded for tax purposes since the debts have no substance. Although the notes seem to be secured by the motion pictures, they are not secured since the motion pictures are owned by Columbia to whom the purported debts are owed. These notes are payable solely out of receipts from the distribution by Columbia of its own motion pictures. The nonrecourse nature of the debts and the provisions for retaining it were mere paper transactions lacking economic substance. Knetsch v. United States , 364 U.S. 361 (1960) ; Durkin v. Commissioner, supra ; Tolwinsky v. Commissioner, supra ; Karme v. Commissioner ; 73 T.C. 1163 (1980) , *133 affd. 673 F.2d 1062 (9th Cir. 1982) .
These transactions were so structured that there was no economic incentive for the partnerships to pay off the purchase notes despite the unquestioned across-the-board high quality of the films. Neither Columbia nor the partnerships ever expected payments to be made on the notes except from the distributable gross receipts earned by the respective film. Since only one out of any six films could be expected to earn its own production costs, neither Columbia nor the partnerships expected, nor could they expect, that each of the films would earn its own production costs when they entered into these transactions. At those times in 1973 and 1974, respectively, the films had not been released to the public. It is undisputed that the motion picture business is a risky business, and that prior to release of any film, public acceptance is difficult to predict, with swings in mood from one month to the next. Prior to the release of the films, it was impossible to determine whether there would be sufficient distributable gross receipts to satisfy any one of the notes. Marcus testified that Columbia's production, advertising, *134 and distribution people had monthly meetings at which there would be estimates on the gross of upcoming films. Yet Persky admitted that he did not ask Columbia for such projections nor did he seek independent appraisals. See Estate of Baron v. Commissioner, supra . We were not favored with any of Columbia's appraisals prior to release of the films, however optimistic they may have been. We find that the notes never had any *618 reality aside from their anticipated tax consequences which were to increase the depreciable basis of each film and to provide substantial interest deductions. Law v. Commissioner , 86 T.C. at 1100 ; see Goldstein v. Commissioner , 364 F.2d at 740 . As we have indicated, once we have determined that the partnerships only had an income interest in the earnings from the films, whatever appearance of substance the notes may have had, disappeared.
Petitioners make much of the fact that under the 1973 and 1975 distribution agreements, the partnerships would be entitled to 100 percent of the net profits from the films, if receipts were sufficient to pay off the notes. *135 In 1973 and 1975, the likelihood that the partnerships would receive 100 percent of the net profits was as unlikely as in Tolwinsky v. Commissioner, supra , and Law v. Commissioner, supra , where those partnerships likewise were entitled to 100 percent of net profits if the notes were paid. The partnerships never became entitled to 100 percent of distributable gross receipts for four of their five films during their 10-year useful lives. This is not a surprise, since the receipts of these four films in the first two years, during which the greatest revenues normally are generated, did not satisfy their respective notes. Due to fortuitous and unexpected circumstances, "Shampoo" was an exceptional success, and Vista became entitled to 100 percent of the distributable gross receipts of that film. It is not unusual to use a net profits interest when calculating a participant's interest in a film. The third-party participants have substantial net profits interests with respect to the instant films. The third-party participants are entitled to approximately 70 percent of any net profits from "Summer Wishes, Winter Dreams," to 57 1/2 percent of any *136 net profits from "Funny Lady," and to 41 3/4 percent of the net profits from "Breakout." Even the third-party participants in "Shampoo" and "Bite the Bullet" have what amounts to net profits interests since their shares of gross profits participations increase when "breakeven" is reached. "Breakeven" would occur when gross receipts equal total expenses, including production costs, unless otherwise defined as a larger amount of gross receipts. These examples show there are many ways to share in exploitation results.
*619 Since we have determined that the partnerships only had an income interest in the distributable gross receipts of the films, the notes are disregarded for tax purposes because they are not bona fide debts. Accordingly, no interest deductions are allowable with respect to the notes. However, the amounts mischaracterized and deducted as prepaid interest are to be included in basis as additional payments of principal. Tolwinsky v. Commissioner , 86 T.C. at 1057 ; Siegel v. Commissioner , 78 T.C. at 686-687 .
We find further that the basis for depreciation of each partnership's income interest is the cost *137 outlay of a partnership with respect to a particular film, i.e., the downpayment, the so-called prepayment of interest, and the portion of the management fees the parties have stipulated should be added to basis for the film, which we interpret to mean an allocation to the partnership's income interest in the film. Thus, the basis for Persky-Bright's income interest in "Summer Wishes, Winter Dreams" is $ 327,000. The bases for Vista's income interests are as follows: the basis for "Funny Lady' is $ 2,092,646; the basis for "Breakout" is $ 1,342,646; the basis for "Shampoo" is $ 1,292,646; and the basis for "Bite the Bullet" is $ 1,292,646.
We next consider the extent to which the partnerships are entitled to depreciation based on the income-forecast method of depreciation. This method of depreciation ties the amount of depreciation deduction allowable for each year to the amount of income produced for that period. Siegel v. Commissioner , 78 T.C. at 692 . This method may be used with respect to the depreciation of contract rights to a film. Durkin v. Commissioner, supra .
The income-forecast method requires the application *138 of a fraction, the numerator of which is the income from the motion picture for the taxable period, and the denominator of which is the estimated total income from the motion picture during its useful life. The cost of the motion picture is multiplied by such fraction to calculate the depreciation allowed for such taxable period. Rev. Rul. 60-358 , 1960- 2 C.B. 68 , as amplified by Rev. Rul. 64-273 , 1964- 2 C.B. 62 . The term "income" means the taxpayer's net, rather than gross, income. Gordon v. Commissioner , 766 F.2d 293 (7th Cir. 1985) , affg. a Memorandum Opinion of this Court; *620 Durkin v. Commissioner , 87 T.C. at 1374 ; Siegel v. Commissioner , 78 T.C. at 693 .
The actual depreciation of motion pictures is not directly related to the appropriate depreciation expenses of contract rights to funds from the exploitation of such pictures. Durkin v. Commissioner , 87 T.C. at 1374 . Thus, in the case of a taxpayer who owns such a contract right to funds from the exploitation *139 of a motion picture, the income-forecast method requires the application of a fraction, the numerator of which is the taxpayer's net income from the contract right for the taxable period, and the denominator of which is the estimated total income from the contract right of the taxpayer. The cost of the contract right is multiplied by such fraction to calculate the depreciation allowable for a taxable year.
In these cases, the partnerships computed their depreciation deductions on the premise that they owned the respective films. Their depreciation deductions for each film were based on Columbia's gross receipts less distribution fees, releasing costs, motion picture association dues, and taxes for that film. Thus, the partnerships improperly used distributable gross receipts or, with respect to the motion pictures with third-party participations, distributable gross receipts plus third-party participations in calculating the depreciation deductions under the income-forecast method. Aside from all else, 16 the partnerships' calculations were excessive because they were based on the erroneous premise that the partnerships owned the films.
*140 The parties agree that the partnerships are entitled to use the income-forecast method of depreciation. In order to give effect to this agreement, the partnerships will be required to recalculate their depreciation deductions based on their net earnings from their contract rights. During the years in issue, the values of these contract rights at the end of their anticipated useful lives were so negligible that salvage values need not be taken into account. In the numerator, the partnerships must use their net income figures shown in *621 the summary schedules as the "net after debt service." In the denominator, the partnerships should have used the estimated net income from their contract rights. Under the circumstances of these cases, since the net incomes from the partnerships' contract rights over the period 1973-84 for Persky-Bright and the period 1975-84 for the other four films are known and shown on the summary schedules as "net after debt service," that figure for each film should be used as the denominator. These fractions are then to be multiplied against the cost of the contract rights as hereinbefore determined to arrive at the annual depreciation deductions *141 until the cost basis of each contract right is recovered. In this manner, the depreciation deductions will be tied to the income produced by the contract rights for each period.
The Persky-Bright partner claimed an investment tax credit on his 1973 return, and the Vista partners claimed investment tax credits on their 1975 returns. Each 7-percent investment tax credit was based on that partner's distributive share of the entire purchase price for each film.
Although the statutory notices of deficiency did not mention section 48(k) and section 804 of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1591-1596, in disallowing the investment tax credits, we are satisfied that petitioners were well aware long before trial that respondent was relying on those provisions. This case is not like Leahy v. Commissioner , 87 T.C. 56 (1986) , which was submitted fully stipulated. Accordingly, we have exercised our discretion under Rule 41 and allowed respondent to file amendments to his answers in the appropriate dockets to conform to the evidence and to assert that the investment tax credits should be disallowed under section 48(k) and section 804 of the Tax *142 Reform Act of 1976. The Commissioner bears the burden of proving that these allegations are correct. Rule 142(a); Durkin v. Commissioner , 87 T.C. at 1382-1383 .
Petitioners' position is that in 1973 and 1975, the years the films were placed in service, the investment tax credit was equal to 7 percent of the "qualified investment" under *622 section 46(a)(1). 17 The "qualified investment" was defined as the "applicable percentage" of the "basis" of the "qualifying property" placed in service by the taxpayer during the taxable year. Sec. 46(c)(1). When the useful life of the qualifying property was 7 years or more, the applicable percentage was 100 percent. Sec. 46(c)(2). Respondent's position is that under section 46(k) petitioners may claim an investment tax credit of 7 percent based on their "proportionate share of any loss which may be incurred with respect to the production costs of each film," and therefore their basis for calculating the credit is the cash (cash downpayment plus prepaid interest) which the respective partnership paid to Columbia for each film. Respondent also contends that under section 48(k)(2) for Vista and section *143 804(c)(1)(A) of the Tax Reform Act of 1976 for Persky-Bright, petitioners' applicable percentage is 66 2/3 percent rather than the 100 percent claimed.
Section 48(k) was enacted by section 804 of the Tax Reform Act of 1976 to clear

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4599055. Public record. Not legal advice.