# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A2f1c1c7b303430ff ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T.C. Memo. 1996-455 UNITED STATES TAX COURT MEDIEVAL ATTRACTIONS N.V.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 20532-91, 20533-91, 20534-91, 20535-91, 20537-91, 20538-91, 15975-92, 16122-92, 8587-93, 8923-93. Filed October 9, 1996. Lawrence L. Hoenig, Stephen J. Martin, Lisa F. Cetlin, A. Keller Young, and David I. Bass, for petitioners. 1 Cases of the following petitioners are consolidated herewith: Medieval Attractions B.V., Successor in Interest to Medieval Attractions N.V., docket No. 20533-91; Medieval Dinner & Tournaments, Inc., Successor in Interest to Medieval Attractions N.V., docket No. 20534-91; Medieval Attractions N.V., docket No. 20535-91; Medieval Attractions B.V., Successor in Interest to Medieval Attractions N.V., docket No. 20537-91; Medieval Dinner & Tournament, Inc., Successor in Interest to Medieval Attractions N.V., docket No. 20538-91; Medieval Show, Inc., docket No. 15975-92; Medieval Show, Inc., docket No. 16122-92; Medieval Dinner & Tournament, Inc., docket No. 8587-93; and Medieval Dinner & Tournament, Inc., docket No. 8923-93. - 2 Howard P. Levine, Benjamin A. deLuna, Kim A. Palmerino, and Robert F. Conte, for respondent. Table of Contents FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 8 I. Background . . . . . . . . . . . . . . . . . . . . . . 9 II. Expansion to the United States . . . . . . . . . . . . A. Florida--Personnel and Pre-1986 Corporate Structure . . . . . . . . . . . . . . B. California--Personnel and Pre-1986 Corporate Structure . . . . . . . . . . . . . . 11 11 III. Continued Development . . . . . . . . . . . . . . . . 25 IV. Contracts . . . . . . . . . . . . . . . . . . . . . . 28 V. Coopers & Lybrand Planning and Petitioners' Documentation . . . . . . . . . . . . . 29 VI. Trademarks and Copyrights . . . . . . . . . . . . . . 52 VII. Section 351 Transfers . . . . . . . . . . . . . . . . 54 VIII. California and New Jersey Expansion . . . . . . . . . A. California . . . . . . . . . . . . . . . . . . . . B. New Jersey . . . . . . . . . . . . . . . . . . . . C. C&L Advice . . . . . . . . . . . . . . . . . . . . 59 59 60 61 IX. Dividends 64 X. Marketing Agreement . . . . . . . . . . . . . . . . . 66 XI. Commercial Paper . . . . . . . . . . . . . . . . . . . 67 XII. Royalty Transactions Relied Upon in Federal Tax Returns . . . . . . . . . . . . . . . . 74 XIII. Federal Tax Returns . . . . . . . . . . . . . . . . . A. MTNV/MSI . . . . . . . . . . . . . . . . . . . . . B. MANV/MDT . . . . . . . . . . . . . . . . . . . . . C. Eurotor . . . . . . . . . . . . . . . . . . . . . 75 75 78 80 XIV. Certified Audit . . . . . . . . . . . . . . . . . . . 80 XV. IRS Audit . . . . . . . . . . . . . . . . . . . . . . 81 . . . . . . . . . . . . . . . . . . . . . . 20 - 3 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . 83 I. Management and Consulting Fees . . . . . . . . . . . . A. Eurotor . . . . . . . . . . . . . . . . . . . . . 1. Services . . . . . . . . . . . . . . . . . . . 2. Compensation in Proportion to Stockholdings . B. Royal Catering . . . . . . . . . . . . . . . . . . C. A. Gelabert, Santandreu, and Segui . . . . . . . . 83 86 86 87 92 93 II. Franchise Transactions and Royalty Fees 95 III. Interest Expense and Guarantee Fees Resulting From Lump-Sum Franchise Payments . . . . . . . . . . 111 IV. Interest Deductions on the Section 351 Transactions . . . . . . . . . . . . . . 121 V. The $236,313 That MDT Paid to MSI as a Marketing Fee . . . . . . . . . . . . . . . 128 VI. New Jersey and California Expansion Expenses . . . . . 129 VII. Additions to Tax and Penalties for Fraud and Negligence . . . . . . . . . . . . . . . . 131 A. Fraud . . . . . . . . . . . . . . . . . . . . . . 131 B. Negligence . . . . . . . . . . . . . . . . . . . . 137 VIII. Substantial Understatement and Increased Interest . . 142 A. Substantial Understatement . . . . . . . . . . . . 142 B. Increased Interest . . . . . . . . . . . . . . . . 143 IX. Withholding of Tax at the Source . . . . . . . . . . . 144 A. Interest That MDT and MSI Paid to MABV and MTBV, Respectively . . . . . . 146 B. Franchise Fees That Were Paid by MANV to Manver in Fiscal Year Ended November 30, 1987 . . . . . . 147 C. MDT and MSI Payments to Manver in March 1988 . . . 148 D. Amounts That MANV, MSI, and MDT Paid to Eurotor as Management and Consulting Fees . . . . . . . . . 149 E. Guarantee Fees Paid to Dapy and Roundabout in Connection With the Commercial Paper Transactions . . . . . . . . . 150 X. Failure To Deposit Withholding Tax . . . . . . . . . . 151 . . . . . . . - 4 Table of Entity Abbreviations ANZ . . . . . . . . . . . . . Australia and New Zealand Bank Amsrott . . . . . . . . . . . Amsrott, N.V. Attractours . . . . . . . . . Attractours, N.V. C&L . . . . . . . . . . . . . Coopers & Lybrand CANV . . . . . . . . . . . . . Corporate Agents, N.V. Calinvest . . . . . . . . . . Calinvest, N.V. Celin . . . . . . . . . . . . Celin, N.V. Dapy . . . . . . . . . . . . . Dapy, N.V. Edemle . . . . . . . . . . . . Edemle, N.V. Estaspan . . . . . . . . . . . Estaspan, Ltd. Etano . . . . . . . . . . . . Etano, N.V. Eurotor . . . . . . . . . . . Europea de Espectaculos, Cenas y Torneo Medievales, S.A. Futureprom . . . . . . . . . . Futureprom, N.V. GCI . . . . . . . . . . . . . Glendale Castle, Inc. Gatetown . . . . . . . . . . . Gatetown Limited Harris . . . . . . . . . . . . Harris, Lippman & Co. Holiday . . . . . . . . . . . Holiday Tours, N.V. Inverspan . . . . . . . . . . Inverspan, N.V. KDS . . . . . . . . . . . . . Kingdom of Dancing Stallions LL . . . . . . . . . . . . . . Lyon & Lyon Lebasi . . . . . . . . . . . . Lebasi, N.V. Lince . . . . . . . . . . . . Lince, N.V. MABV . . . . . . . . . . . . . Medieval Attractions, B.V. MANV . . . . . . . . . . . . . Medieval Attractions, N.V. MCI . . . . . . . . . . . . . Meadowland Castle Inc. MDT . . . . . . . . . . . . . Medieval Dinner & Tournament, Inc. MICV . . . . . . . . . . . . . Manver International, C.V. MSI . . . . . . . . . . . . . Medieval Show, Inc. MTBV . . . . . . . . . . . . . Medieval Times, B.V. MTNV . . . . . . . . . . . . . Medieval Times, N.V. Manver . . . . . . . . . . . . Manver, N.V. NCB . . . . . . . . . . . . . National Community Bank Primavert . . . . . . . . . . Primavert, N.V. Promidux . . . . . . . . . . . Promidux, N.V. Protravol . . . . . . . . . . Protravol Limited RC . . . . . . . . . . . . . . Royal Catering, Inc. Roundabout . . . . . . . . . . Roundabout Tours, N.V. SDCI . . . . . . . . . . . . . San Diego Castle, Inc. Slider . . . . . . . . . . . . Slider, N.V. Spectrust . . . . . . . . . . Spectrust, N.V. TM . . . . . . . . . . . . . . Torneo Medieval, S.A. Wayout . . . . . . . . . . . . Wayout Tours, N.V. - 5 MEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Chief Judge: Respondent determined deficiencies and additions to tax and penalties in petitioners’ Federal income taxes as follows: Docket No. 20532-91 Tax Year Ended Deficiency 11/30/87 $929,752 Additions to Tax Sec. Sec. 6653(a)(1)(A) 6653(a)(1)(B) $46,488 50% of interest due on $929,752 Sec. 6661 $185,950 Docket No. 20533-91 Tax Year Ended Deficiency 11/30/87 $929,752 Additions to Tax Sec. Sec. 6653(a)(1)(A) 6653(a)(1)(B) $46,488 50% of interest due on $929,752 Sec. 6661 $185,950 Docket No. 20534-91 Tax Year Ended Deficiency 11/30/87 $929,752 Additions to Tax Sec. Sec. 6653(a)(1)(A) 6653(a)(1)(B) $46,488 50% of interest due on $929,752 Docket No. 20535-91 Year Deficiency 1987 $21,600 Docket No. 20537-91 Year Deficiency 1987 $21,600 Sec. 6661 $185,950 - 6 Docket No. 20538-91 Year Deficiency 1987 $21,600 Docket No. 15975-92 Tax Year Ended Deficiency Sec. 6653(b)(1)(A) Additions to Tax Sec. Sec. 6653(b)(1)(B) 6653(b)(1) 7/31/88 $808,755 $606,566 50% of interest due on $808,755 -- $202,189 7/31/89 869,682 -- -- $652,261 217,420 Sec. 6661 Docket No. 16122-92 Year Deficiency Addition to Tax Sec. 6653(b)(1) 1988 $1,378,634 $1,078,379 Docket No. 8587-93 Year Deficiency Addition to Tax and Penalties Sec. Sec. Sec. 6653(a) 6656(a) 6662(a) 1988 1989 $2,742,859 428,739 $137,143 -- $284,657 52,009 -$85,747 Docket No. 8923-93 Tax Year Ended Deficiency Additions to Tax and Penalty Sec. Sec. Sec. 6653(a)(1) 6661 6662(a) 11/30/88 11/30/89 $2,526,905 2,929,741 $126,345 -- $631,726 -- -$585,948 After concessions, the issues remaining for decision are: (1) Whether amounts deducted as management and consulting fees are reasonable payments for services rendered; (2) whether the - 7 franchise transactions petitioners entered into were bona fide so that petitioners are entitled to deduct royalty payments, or whether an adjustment under section 162 or 482 is warranted; (3) whether amounts petitioners deducted as interest and guarantee fees were associated with bona fide debt; (4) whether amounts petitioners deducted as interest in section 351 transactions were associated with debt; (5) whether Medieval Dinner & Tournament, Inc., is entitled to deduct $236,313 that it paid Medieval Show, Inc., as a marketing fee; (6) whether petitioners may claim as current deductions the costs associated with New Jersey and California expansions; (7) whether some of petitioners are liable for the additions to tax and penalties for fraud, or in the alternative, negligence; (8) whether some of petitioners are liable for the additions to tax for substantial understatement of income tax liability and increased interest; (9) whether some of petitioners are liable for withholding of tax at the source for interest, debt guarantee, consulting and management fees, royalty payments, and franchise fees; and (10) whether Medieval Dinner & Tournament, Inc., is liable for the section 6656 addition to tax for failure to deposit withholding of tax. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 8 Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. The evidence from 30 days of trial included 6,368 pages of transcript and thousands of exhibits, many of which contained multiple parts and/or were duplicates of other exhibits. The failure of the parties to engage in timely, good faith, voluntary and orderly exchange of documents resulted in the necessity of 39 separately filed stipulations through the course of the trial, without logical or consistent sequence or organization. It is not reasonable to reproduce here all of the findings requested by the parties. Many of them are exaggerated extrapolations or unrealistic interpretations of the evidence. We have set forth only those findings that are necessary to explain and dispose of the issues for decision in these cases. Detailed findings concerning certain documents are necessary because of disputes as to the sham or fraudulent nature of petitioners' transactions. Documents and facts at times subsequent to the years in issue are set forth because they are relevant in determining when or whether other documents were prepared or events occurred. The other agreed facts are incorporated in our findings by this reference. FINDINGS OF FACT Petitioner Medieval Show, Inc. (MSI), is a corporation organized under the laws of Florida with its principal place of business in Kissimmee, Florida. Petitioner Medieval Dinner & - 9 Tournament, Inc. (MDT), is a corporation organized under the laws of California with its principal place of business in Buena Park, California. MDT is a successor in interest to Medieval Attractions, B.V. (MABV), a corporation organized under the laws of The Netherlands, and MABV is a successor in interest to Medieval Attraction, N.V. (MANV), a corporation organized under the laws of the Netherlands Antilles. I. Background The concept for entertainment facilities that came to be known as Medieval Times originated in Spain. During the late 1960's and into the 1970's, Jose Montaner (J. Montaner) and his sisters owned a successful barbeque in Son Termens, Spain. J. Montaner’s family had lived for centuries on the island of Mallorca off the coast of Spain. J. Montaner’s mother was the Countess of Peralada, and his family held the rights to use the title of the Viscount of Rocaberti. J. Montaner had an interest in medieval history and incorporated that interest into a dinner theater and medieval show located in L’Alqueria in Spain. After the L’Alqueria show became successful, J. Montaner moved the show to Son Termens. In July 1973, J. Montaner, his sisters, Francisco Bosch Oliver (Bosch), and Jose Planas Llabres de Jornets incorporated Son Termens, S.A., to operate a dinner theater in Son Termens. The show at Son Termens featured a meal and medieval entertainment that included period costumes, knights on - 10 horseback, and jousting. The show resembled scenes from the movie “El Cid”, which J. Montaner had seen prior to creating the show. The show was run by the corporation, and J. Montaner was a minority shareholder. Jaime Climent (Climent) had several businesses in Benidorm, Spain, including a barbeque restaurant with seating for 2,000 people, called Rancho Grande. Climent was familiar with J. Montaner’s show and wanted to bring it to Benidorm. Climent contacted J. Montaner, and they agreed to open a show in Benidorm. On January 25, 1977, Torneo Medieval, S.A. (TM), was incorporated in Spain. The initial shareholders of TM were Climent, 45 percent; J. Montaner, 13 percent; Juan Colom Valcaneras, 15 percent; Juan-Pedro Rousselet Barbaud (Rousselet), 15 percent; and Bosch, 12 percent. TM operated a medieval theme dinner theater in Benidorm in a castle known as Castell Comte D’Alfaz. Some of the Son Termens employees were transferred to Benidorm to assist with opening the show. The Benidorm show was similar to the Son Termens show, and, over time, innovations were incorporated into the Benidorm show. The show in Benidorm became profitable 2 to 3 years after it began operating. Neither J. Montaner, his sisters, nor the other shareholders of Son Termens, S.A., were compensated by TM for the use of the medieval dinner show concept. - 11 II. Expansion to the United States A. Florida--Personnel and Pre-1986 Corporate Structure Cristobal Segui (Segui) was a successful Spanish businessman. He owned an interest in Son Amar, a large nightclub operated on Mallorca that catered to tourists. He also owned an interest in La Granja, a medieval village on Mallorca. Alfonso Chavez (Chavez) was a U.S. citizen who lived in the same building as Segui. Chavez was interested in finding an attraction to take to the United States and spoke to Segui about the show in Benidorm. J. Montaner also had been interested in opening a show in the United States. Segui discussed Chavez’s proposal with J. Montaner, and they decided to put together a group of investors interested in opening a medieval show in the United States. The original group consisted of J. Montaner; Segui; Climent; Pedro Montaner (P. Montaner), J. Montaner’s nephew; Johan Kahne (Kahne), a business associate of P. Montaner; and Vincente Valiente (Valiente). This group of investors and Martin Santandreu (Santandreu), who joined the group later, comprised the Spanish investors. The Spanish investors were successful businessmen, each with a net worth exceeding $1 million. Resumes provided to a bank in a loan application filed by Inverspan, N.V. (Inverspan), during 1982 or 1983 contained personal information on the Spanish investors and included the following: - 12 P. Montaner: 39 years old; lawyer; president of 12 companies; owns various parcels of land in Spain; personal estate value of $6 million. J. Montaner: 61 years old; diploma in tourism; part owner of a tourist complex that holds 3,000 people; owns flats and plots of land; personal estate value of $3.5 million. Santandreu: 48 years old; bachelor's degree; 100-percent owner of three perfume stores; 25-percent owner of a financing company; 20- to 50-percent owner in several other businesses, including nudist camps and nightclubs; owner of land and property; personal estate value of $4.1 million. Segui: 41 years old; bachelor's degree; 100-percent owner in two real estate companies; 25- to 50-percent owner in other companies, including a museum, restaurant, and tourist attractions; owner of land in Spain; personal estate value of $2.75 million. Climent: 45 years old; business administration; part owner of dinner show, hotel, jousting show; personal estate value of $1 million. In 1980, Segui and J. Montaner traveled to the United States to study the tourism market. June 1980. They visited Orlando, Florida, in In October 1981, a group of the Spanish investors came to the United States to find a location for the dinner show. Climent noticed a suitable parcel of land on Highway 192 in - 13 Kissimmee, Florida. A sales contract was signed to purchase the Highway 192 parcel in October 1981. The Spanish investors hired Chavez to assist with the Florida plans. Chavez and his wife were heavily involved in the preliminary development and organization of the Florida operation and frequently represented the Spanish investors. Chavez’s activities included buying land and looking for estimates, contractors, engineers, architects, attorneys, accountants, and banks. Chavez signed the contract to purchase the Florida land for the castle and located Charles H. Parsons (Parsons), a Florida architect. The land contract named the buyer as “an Offshore Corporation to be formed”. In 1982, Parsons traveled to the Don Pancho Hotel in Spain to meet with several of the Spanish investors regarding the construction of the castle in Kissimmee. Parsons viewed the castle at Benidorm and was given preliminary drawings that a Spanish architect had made of the Benidorm castle. eventually signed the contract hiring Parsons. Chavez The Spanish investors had several other meetings at the Don Pancho Hotel to discuss the U.S. venture. During one of these meetings, Santandreu promised the Spanish investors that the American company would compensate them for their work. The Spanish investors began to form several corporations to develop the Florida project. The first corporation, Inverspan, was incorporated on November 19, 1981, in the Netherlands - 14 Antilles with the assistance of Florida counsel, Thomas Allen (Allen) of Maguire, Voorhis & Wells, and Netherlands Antilles attorneys, L.A. Haley and Y.L. Cuales of Corporate Agents, N.V. (CANV). Inverspan was created to own the land and building used for the Florida castle. The shareholders of Inverspan were: Chavez and Climent, 11.1 percent each; Kahne, J. Montaner, and P. Montaner, 13.08 percent each; Santandreu and Segui, 12.62 percent each; and Valiente, 13.32 percent. (Family members such as husbands and wives who both held shares are included under the family name.) Medieval Times, N.V. (MTNV), was incorporated in the Netherlands Antilles on December 21, 1982, with the assistance of Allen and CANV. MTNV was formed to operate the Florida castle. The MTNV shares were held by the same individuals and in the same proportions as the Inverspan stock. Inverspan paid the costs of constructing the Florida castle with a $2.65 million loan from a bank. The MTNV-Inverspan shareholders pledged $1.4 million collateral for the loan. Before the name “Medieval Times” was selected, the name “El Cid” and “A Dinner Theater in a Castle” were considered. The movie “El Cid” had been released in 1961 and contained scenes that depicted a medieval castle with towers, period costumes, jousting, sword fighting, and knights, all of which became elements of the Medieval Times show. The Spanish investors considered hiring Charlton Heston, the star of “El Cid”, to open - 15 the MTNV castle in Florida, but they rejected the idea because of the expense. The Spanish investors needed a vehicle in which to invest and travel to the United States because it was illegal under Spanish law for Spanish citizens to invest in the United States without permission from the Spanish Government. The Spanish investors formed Europea de Espectaculos, Cenas y Torneo Medievales, S.A. (Eurotor), in Spain on September 1, 1982, for the purpose of carrying out, among other objectives, the promotion and development of public entertainment either in Spain or abroad. Eurotor’s original shareholders were the Spanish investors: Climent, 25 percent; Valiente, 12.5 percent; Santandreu, 12.5 percent; Segui, 12.5 percent; J. Montaner, 12.5 percent; P. Montaner, 12.5 percent; and Kahne, 12.5 percent. Of this group, only J. Montaner and Climent were shareholders of TM, which operated the show in Benidorm. In approximately November or December 1982, Eurotor requested permission from the Spanish Government to invest in the United States. Permission was granted in March 1983. The Spanish investors had earlier chosen to invest in Inverspan and MTNV without reporting their investments to the Spanish Government. They chose not to report because they believed the process was complicated and difficult and because they thought the response from the Spanish Government would be negative. - 16 Subsequent to the formation of MTNV, several more Netherlands Antilles companies were formed from 1983 through 1986 for use by the Spanish investors. The Spanish investors were concerned about confidentiality and had the stock of all of the corporations, including Inverspan and MTNV, issued in bearer form to protect the identity of the shareholders. The Spanish investors decided to protect their identities further by using corporations to represent their interests. The corporations that were created to represent the Spanish investors with their owners were: Spectrust, N.V. (Spectrust)--Valiente (Valiente died in 1988, and Climent married Valiente’s widow and took control of Spectrust); Promidux, N.V. (Promidux)--P. Montaner; Dapy, N.V. (Dapy)--Kahne; Attractours, N.V. (Attractours)--J. Montaner (P. Montaner, J. Montaner, and Kahne acted as a group in representing and voting the shares of Promidux, Dapy, and Attractours); Roundabout Tours, N.V. (Roundabout) (and later Primavert, N.V. (Primavert))--Santandreu; Holiday Tours, N.V. (Holiday)--Segui; and Wayout Tours, N.V. (Wayout)--Climent. These corporations, each owned by a Eurotor shareholder, were known as the Eurotor group of companies. After the corporations were formed, the bearer shares of MTNV stock that were owned by each of the Eurotor shareholders were transferred to each shareholder’s respective Netherlands Antilles corporation. After the stock transfers, the MTNV shareholders consisted of the Netherlands Antilles corporations: Spectrust; - 17 Promidux; Dapy; Roundabout; Attractours; Wayout; Holiday; and, in his individual capacity, Chavez. Chavez, a U.S. citizen, was not a Eurotor shareholder and did not have a Netherlands Antilles corporation representing his interest in MTNV. Andres Gelabert (A. Gelabert) worked for Segui at Segui’s nightclub in Spain. He was sent to Florida to supervise construction and to set up the operations of the Florida castle. On May 16, 1983, Allen, on behalf of MTNV, offered to A. Gelabert, in writing, the position of managing director of MTNV. The offer provided for a salary of $24,000 per year and 3 percent of gross revenues. A. Gelabert’s duties included supervising the construction of the castle in Florida; recruiting and training 70 to 100 persons to be employed by MTNV, particularly kitchen staff; ensuring all aspects of the production, including verifying that the costumes and props were historically accurate; and developing marketing and public relations strategies. The offer was contingent on A. Gelabert’s getting approval from the U.S. Immigration and Naturalization Service to work in the United States. Royal Catering, Inc. (RC), was incorporated in Florida by Allen on June 30, 1983. corporate director. A. Gelabert was listed as the sole A. Gelabert was the sole shareholder of RC during the years in issue. RC was purportedly established to provide catering services to the castle. Initially, RC was actually used only as a vehicle to obtain U.S. visas for - 18 A. Gelabert and Jose “Pepe” Sans (Sans). loaned $100,000 to RC. June 1985. account. The MTNV shareholders The loan was repaid between March and The interest on the loans was paid from an MTNV During the years in issue, RC’s “books and records” were petitioners’ books and records. In addition to A. Gelabert, Climent assembled other personnel in Spain to bring to the United States to assist with the Florida operation. These individuals included George Stonecrow (Stonecrow); Vicente Valiente, Jr. (Valiente, Jr.); Jose “Pepe” Castro (Castro); and several knights (Tino Brana, Victor Lara, Robin Brevik, and Javier Elvira). Climent also had 140 crates of materials sent to Florida from Spain. The materials included costumes, weapons, objects for the horses, and decorations. By the end of 1982, Chavez was no longer involved in the daily Florida operation that was run primarily by A. Gelabert and Castro. A. Gelabert was in charge of the castle construction, aspects of the show, and the food and beverages. A. Gelabert and Castro also secured construction bids, worked with the banks on loans, worked with the engineers and contractors, applied for licenses and certificates such as employer identification numbers and liquor licenses, procured services, paid bills, purchased restaurant equipment, provided for the care of the horses, and coordinated the kitchen design and construction. - 19 Stonecrow was knowledgeable about the medieval era and maintained the historical authenticity of the show. designed and sewed costumes and painted murals. Stonecrow Stonecrow was the producer of the MTNV show in Florida and was the master of ceremonies when the Florida castle opened in December 1983. Charles C. Bellows (Bellows) was hired by MTNV as the marketing manager in 1983. Bellows heard about the castle’s opening in Florida and contacted MTNV. He met with Segui and Santandreu, who offered him the position. Bellows was experienced in the entertainment market, having previously worked for Holiday Inn Worldwide Sales and then for Ringling Brothers Barnum & Bailey Circus World in Florida. Bellows hired an assistant, Andrea Kudlacz (Kudlacz), who had previously worked for Disney World in Florida. Bellows created a marketing plan and budget, hired staff and marketing consultants, and made contacts with the Florida tour industry. He established procedures for the marketing department. He and his staff developed brochures and other printed marketing materials. Bellows and Kudlacz oversaw the production and purchase of print, radio, and television advertising for MTNV. Bellows’ wife designed the letter style used to write the words “Medieval Times”. Bellows originally reported to Segui but began reporting to A. Gelabert when A. Gelabert was appointed general manager of the Florida operation. In some instances, the Spanish investors would review Bellows’ plans, give directions, and make - 20 suggestions regarding marketing actions that they wanted Bellows to take. In 1985, Bellows set up an in-house advertising agency at MTNV. Bellows monitored MTNV's competition in the central Florida area. The companies that MTNV considered as competition included "King Henry's Feast", which was operating during the mid-1980's. King Henry's Feast was a medieval dinner show that seated 600 to 700 customers. The customers were served a meal and watched a show that included sword fights with armor and acrobats. For a period of time, King Henry's Feast featured jousting, although it was not part of the dinner show. Leandro Galindo (Galindo) met A. Gelabert while A. Gelabert was working on the Florida castle. A. Gelabert sent Galindo to a horse training school in Florida for about 6 months so that Galindo could become a knight. set up a photography department. A. Gelabert also asked Galindo to Galindo researched equipment and presented the information to A. Gelabert. A. Gelabert chose a photography equipment company that provided a 2-week training session with the purchase of equipment. To the best of Galindo’s knowledge, no one at MTNV knew anything about photography equipment. Galindo set up the lab and hired and managed the six employees who worked in the photography department. The general concept of taking pictures at the castle was not new. Photographs were taken and distributed to customers at Son Termens in Spain. The methods used to take the pictures and - 21 the type of shots available to the customers, however, were new. Galindo and his staff experimented with their own methods of making photography sales profitable. Some ideas were not successful and some ideas, such as group shots, were successful and became part of MTNV’s operation. Climent moved to Florida in the fall of 1983 and stayed until the end of January 1984. Segui, Santandreu, and P. Montaner also came to the United States to assist with the opening of the Florida castle. After the Florida opening, the Spanish investors returned to Spain. Some of the investors visited the United States occasionally after their return to Spain. B. California--Personnel and Pre-1986 Corporate Structure In the spring of 1985, the Spanish investors discussed the possibility of expanding to California. In June 1985, Bellows and Kudlacz went to Southern California and met with Wesley Taylor (Taylor), a commercial real estate broker. Taylor had a listing on property that had formerly belonged to a company called the Kingdom of the Dancing Stallions (KDS) in Buena Park, California. In the fall of 1985, A. Gelabert met with Taylor to discuss the KDS property. Initially, Kahne and J. Montaner advised against expanding to California due to several factors, including the cost of a new castle. Santandreu and Segui, however, concluded that the cost would be reduced by altering the existing building on the KDS - 22 property to fit a medieval theme even though it would be dissimilar to the Florida castle. The reassessment of expenses helped persuade the Spanish investors to proceed in California. A. Gelabert signed the contract to purchase the KDS property on December 4, 1985. Taylor did not meet with any of the Spanish investors until January 1986. Expenses incurred by Santandreu, Segui, J. Montaner, and Kahne in connection with investigating the California castle were paid by MTNV. The same type of corporate organization was used to operate the California castle as the Florida castle. On December 30, 1985, Calinvest, N.V. (Calinvest), was incorporated in the Netherlands Antilles. The purpose of Calinvest was to own the land and building used for the California castle. On December 31, 1985, MANV was incorporated for the purpose of operating the Buena Park castle. The shareholders of Calinvest and MANV were as follows: Name Dapy (Kahne1) Holiday (Segui1) Primavert (Santandreu1) Promidux (P. Montaner1) Roundabout (Santandreu1) Spectrust (Valiente1) Wayout (Climent1) Royal Catering (A. Gelabert1) Estaspan, Ltd. Santandreu J. Montaner Segui Kahne Interest in MANV Interest in Calinvest 12% 12% 12% 12% 12% 5% 5% 5% 5% 5% 5% 5% 5% 17% 17% 20% 17% 17% 5% 5% 2% - - 23 1 Denotes the owners of the corporations who held the interests in MANV and Calinvest. Estaspan, Ltd. (Estaspan), was a Bermuda corporation controlled by Gavin H. Watson, Jr. (Watson). banker in Florida. operation. Watson was MTNV’s Chavez did not participate in the California Chavez wanted to participate in California, but the Spanish investors specifically excluded him. Sans, who had known Segui since childhood, came over from Spain in late 1985 to run the Florida castle so that A. Gelabert could go to California. Florida operation. Sans took over as general manager of the He had no experience running a dinner show. His experience was limited to operating a restaurant and tour agency in Spain. A. Gelabert went to California in early 1986 to renovate the existing KDS building and to set up the California operation. He hired a general contractor and a kitchen contractor and brought Florida MTNV employees to work on the California castle. A. Gelabert also brought several artists from Florida and hired local artists to paint murals and crests at the California castle. Bellows developed a marketing program for the California castle prior to its opening in 1986. He used the expertise he had acquired in Florida and interviewed and hired new personnel. The California market differed from the Florida market because - 24 the California clients were primarily local residents and not out-of-town tourists. TM did not send property or supplies to California. The Florida castle transferred horses and knights and other equipment and employees to California. Peter Woefel (Woefel), the food and beverage manager of the Florida castle, moved to California to become the food and beverage manager of the California castle. Woefel oversaw the food preparation and kitchen operation and, in May 1987, prepared a procedure review memorandum concerning alcoholic beverage procedures for the California castle. Stonecrow provided extensive services to the California castle from 1986 to 1989. Galindo sent one of his staff to California to establish the California photography lab. was modeled after the Florida lab. The California lab Galindo created an operations manual for the California lab based on his experience in Florida. When the California castle opened, the best knights from the Florida castle were sent to California to work as knights and to train other knights. - 25 III. Continued Development The Florida castle opened in December 1983. Several improvements and changes were made from 1985 to 1989, including demolition of a ramp and a new entry to the existing building; a new lounge; new heating and air conditioning; a new ticket office; new offices; a new kitchen, including marinating tubes; replacing electric stoves with gas stoves; new stables; and a medieval village. The annual Florida attendance figures were as follows: Year Attendance Year Attendance 1984 1985 1986 1987 1988 183,272 257,350 308,391 388,071 399,776 1989 1990 1991 1992 1993 470,000 525,200 550,000 575,000 600,000 The California castle opened in June 1986. From 1986 to 1989, many renovations and additions were made to the California castle. A formal gift shop, Hall of Flags/Arms, and a torture museum were added. Renovations included a redesign of the existing facility, remodeling the banquet facility with a dance floor, and remodeling the kitchen, museum, and bathroom. RC and MDT entered into a Management Agreement that was dated December 1, 1987. of RC. A. Gelabert was the owner and president The agreement called for RC to manage its food and beverage operation. MDT was to provide all of the kitchen facilities and to employ all of the wait staff. RC was to receive 5 percent of gross profits, and MDT was to reimburse RC - 26 for “salary, payroll taxes, insurance and other related expenses for president of Manager, food and beverage manager of Medieval and assistant food and beverage manager of Medieval.” The agreement was notarized on March 8, 1988. Both the Florida and California operations were structured into departments that included marketing, accounting, food and beverage, show, sound and lighting, photography, gift shop, and stables and knights. The department heads reported to the general manager of each castle. The general manager approved changes that were improvements in the operation of the castle and did not substantially change the “theme” of the show. The general managers provided information on the operations to the Spanish investors. Jack Rein (Rein) was a professionally trained actor and dramatic writer. He was hired by the California castle as the emcee a month after it opened in 1986. When Rein commenced his employment, he was given a 10-page outline of the show. Rein began updating the script during 1987 and 1988, making it more complete by adding dialogue for different characters and for the emcee. Every 6 months or so, the ending of the story was changed, and changes were made to the script to reflect the different endings. Rein continued to update and vary the script to reflect dialogue changes in the show. In 1992, Rein prepared a script that became the standard for all of the castles. - 27 Recorded music was used in the Medieval Times shows between 1983 and 1990, including excerpts from “El Cid” and “Conan the Barbarian”. Michael Schwartz (Schwartz) and Dan Friedman (Friedman) composed a soundtrack in 1991 for the Medieval Times shows that was used in all of the castles. Schwartz was an employee of MANV and approached A. Gelabert about the idea of composing an original score. Schwartz and Friedman prepared a demonstration recording for A. Gelabert. A. Gelabert liked the demonstration, so Schwartz and Friedman composed music for the entire show. Schwartz and Friedman produced the music at their own risk and presented it to the Spanish investors. The Spanish investors approved the score and paid Schwartz and Friedman $18,000 for their finished product. The fee was originally paid by MANV through its successor in interest, MDT. In 1989, A. Gelabert met with Michael Hartzell (Hartzell), who was the Director of Entertainment for the Excalibur Hotel and Casino in Las Vegas, Nevada. Hartzell was interested in locating an independent contractor to produce a Medieval Times-type show at the Excalibur. The Excalibur opened the King Arthur's Tournament Show (King Arthur's) in the hotel on June 15, 1990 without the assistance of A. Gelabert or the Medieval Times companies. King Arthur's seated 900 customers and featured a meal, jousting, and knights. The hotel also had a medieval village with 22 shops and five specialty restaurants. As of - 28 1995, Medieval Times had not initiated any type of legal proceeding against the Excalibur in relation to King Arthur's. IV. Contracts Before the Florida castle opened, the Eurotor shareholders wanted assurances that they would be compensated for their assistance in the development of Medieval Times. Allen drafted an agreement, dated January 24, 1983, between MTNV and Eurotor and TM, with Eurotor and TM referred to collectively as Eurotor. The agreement required that Eurotor open an office in Florida and provide management and personnel to assist with the construction and operation of the Florida castle. MTNV agreed to compensate Eurotor with payments of 2 percent of the total estimated cost of the facility (excluding financing costs) during both the creation and development phase of building the castle (for a total of 4 percent) and 50 cents per customer during the operational phase of the castle. The agreement stated that it was to be in effect for a period of 10 years from the date of the agreement. agreement did not refer to any other fee agreements. The The agreement was signed by A. Gelabert for Eurotor, Climent for TM, and Allen for MTNV. The agreement did not mention or refer to a franchise. Prior to drafting the January 24, 1983, contract, Allen had written a list of items that he needed to include in the document. His notes did not contain a reference to any other - 29 agreements. A list of the documents that were in existence in Kissimmee during 1983 referred to the January 24, 1983, contract. V. Coopers & Lybrand Planning and Petitioners' Documentation Coopers & Lybrand (C&L) is a “big six” accounting firm known for its worldwide market. C&L prepared all of the tax returns for the Medieval Times companies beginning with the MTNV return in 1982. In 1985, Santandreu sought the assistance of C&L in Brussels, Belgium, to find a structure that could be used for the nontaxable receipt of payments made to the Spanish investors by MTNV. C&L suggested the use of a nonresident United Kingdom company to Santandreu in a letter dated August 6, 1985. Gatetown Limited (Gatetown) was a United Kingdom corporation registered on or about May 1, 1985, by Nigel Leonard Blood. In March 1986, Segui’s father-in-law, Jose Garcia de Oteyza Romero (de Oteyza), was in contact with Harris, Lippman & Co. (Harris), an accounting firm in the United Kingdom. In an April 1986 letter, de Oteyza sent funds to Harris to acquire Gatetown. The letter stated that “Gatetown Limited will take care of getting paid Royalties and copyrights of a Dinner-Show situated in the U.S.A.” The correspondence also referred to a company called Protravol Limited (Protravol) that would be used for the “buying and selling from Spain to U.S.A. of souvenirs”. The letter informed Harris that the directors of both companies should be de - 30 Oteyza and Jaime Antonio Mayol Castaner (Mayol), Segui’s brotherin-law. In a letter to the United Kingdom taxing authority in 1987, Harris represented that Gatetown commenced business March 1, 1986; that Gatetown’s registered office was in Palma de Mallorca, Spain; and that the nature of the company’s activities was as owner of royalty and copyright agreements. Gatetown’s original incorporators resigned on June 12, 1986, and Mayol and de Oteyza were named as the officers. The Gatetown stock, which consisted of two shares, was held equally by Mayol and de Oteyza as nominees. On May 1, 1986, A. Gelabert sent to Francois A. Nouel (Nouel) of CANV a letter requesting that, among other things, Nouel submit the names of Manver, Lince, and Attractours for approval by the Chamber of Commerce of the Netherlands Antilles. Attractours, Lince, N.V. (Lince), and Manver, N.V. (Manver), were incorporated in the Netherlands Antilles on or about May 16, 1986. Lince was owned by Holiday, Roundabout, Dapy, and Promidux. Manver was owned by Spectrust and Wayout. was owned by Promidux and Dapy. were paid by Wayout. Attractours The Manver incorporation fees Lince was capitalized with $6,000 on May 19, 1986, from an account maintained in the name of Holiday. Ian Forsyth (Forsyth) was the international tax partner at the C&L Los Angeles, California, office from 1986 to 1989. As appears from his handwritten notes and related correspondence, - 31 Forsyth was aware of the Medieval Times company early in 1986, prior to purchase of the California castle. In May 1986, Forsyth met with representatives of the Medieval Times companies at C&L in Los Angeles. During the numerous meetings that occurred, Forsyth met primarily with Santandreu, Jeronimo Onate (Onate), and A. Gelabert. Santandreu and Onate represented the Medieval Times companies and Gatetown or Manver or both. Kenneth H. Kim (Kim) was employed at C&L as a tax manager and assisted Forsyth in the representation and meetings. During a May 20, 1986, meeting, the then-existing structure of the Medieval Times companies was reviewed with Forsyth. Forsyth began to design methods intended to improve the corporate structure of the Medieval Times U.S. entities. Forsyth thought the “branch profits tax” in the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, would make the existing structure of Medieval Times undesirable. Forsyth took notes at these meetings. 1986, contain the following references: Notes dated May 20, trademark attorney. None registered. “Royalties. Which company should own trademark - where? Copyright - Which Co.? 3 Spanish nationals ‘own’. (Florida Co. Not now paying royalties)”. state: “Trademark - offshore. tax [profit]. Problem: Recommend Objective: The notes also 10% [royalty] of pre- Ownership of intangibles.” Additionally, the notes reflect that the Spanish operation - 32 trained the Florida personnel and provided technical and logistical support but that the structure was set by the Florida operation, which sent people to California. agreement, the notes state: Regarding a license “License agreement from foreign corp. to NV-Florida for UK Co.?” Forsyth wanted to determine a method to make payments to the Spanish investors while incurring a minimum amount of U.S. tax. Forsyth developed a plan that he outlined in a letter to Santandreu dated June 4, 1986. Forsyth recommended that the Spanish investors set up a domestic corporation to operate the Florida and California castles and utilize a three-tier corporate operating structure. Specifically, he recommended that MTNV cease operating in the United States, transfer its assets to a Dutch or other nationality subsidiary, and then have the subsidiary transfer its assets to a new operating company incorporated in Florida. Before Forsyth finalized his plan for corporate restructuring, he was waiting for a final ratification of an income tax treaty between the United States and The Netherlands. Forsyth suggested that using a Dutch company as the intermediate tier would have advantages. Forsyth recommended the use of section 351 to transfer the assets from the Netherlands Antilles corporation to the intermediate-tier Dutch corporation and then from the Dutch corporation to the new domestic operating company. - 33 Gordon Thring (Thring) worked in the C&L Los Angeles office. He drafted a letter to Santandreu based on conversations he had with Forsyth. The letter to Santandreu was marked “September draft”, and it stated that C&L had reviewed the advice from the June 4, 1986, letter to take into account recent tax code changes and the recently signed income tax treaty between the United States and The Netherlands with respect to the Netherlands Antilles. The letter affirmed C&L’s recommendation for Medieval Times to use a three-tier corporate structure as suggested in the June 4, 1986, letter. The ostensible advantages of the three-tier structure included limiting U.S. withholding tax to 5 percent for dividends paid to Dutch companies and zero percent for interest paid to Dutch companies, and dividend income from the U.S. company would be tax-exempt in The Netherlands. A section in the September draft letter discussed royalty payments on intangible assets. The letter stated: “We understand that it is intended to license M.T.U.S. [Medieval Times U.S.] to use the ‘Medieval Times’ concept and any material that may be copyrighted.” C&L suggested the use of a Barbados company to license the intangibles to a Dutch company that would in turn license them to the Medieval Times U.S. companies. C&L stated that the advantage to this arrangement was that the royalty income would not be subject to withholding tax in the United States or in The Netherlands. - 34 Forsyth responded to a request from Santandreu in an October 8, 1986, letter that summarized the reasons C&L was recommending the changes to the Medieval Times corporate structure. C&L stated that the problems with the current structure were that a 30-percent withholding tax would apply to royalty payments from MTNV and MANV and that a 30-percent branch profits tax would apply on earnings and interest deemed distributed by the existing Netherlands Antilles companies to nonresidents. C&L’s recommendation included transferring existing operations and real estate to U.S. corporations owned by Dutch holding companies that would in turn be owned by the existing Netherlands Antilles companies. The recommendation also included borrowing in the United States to the maximum extent possible through mortgage loans and working capital to maximize tax benefits, with the funds used to pay dividends and/or reduce capital prior to implementation of the reorganization and prior to the effective date of the new tax act. The result would be to reduce the tax rates for interest from 30 percent to 8.7 percent, for royalties from 30 percent to 2.94 percent, and for dividends from 53.8 percent to 43.9 percent. The October 8, 1986, letter also included a list of things to do to implement the plan, which included determining the entity to own the intangibles (trademarks, copyrights, etc.) and completing licensing agreements; implementing a borrowing strategy; and targeting a completion date of December 31, 1986, - 35 or a November 30 fiscal year for MANV and Calinvest to delay the effect of the 1986 Tax Reform Act with respect to the 30-percent withholding tax. Forsyth listed the information that was required as soon as possible, which included balance sheets; profit and loss statements; profit forecasts; recent tax returns; a listing of all agreements, licenses, etc., that would need to be transferred to the new U.S. subsidiaries; and details of the shareholdings of the Netherlands Antilles companies. Forsyth needed the information to prepare a tax benefit forecast and a final version of the detailed letter he had reviewed with Santandreu. During October 1986, it had not yet been determined who would own the intangibles. While C&L, with the Spanish investors’ knowledge, was drafting documents that named Manver as the “licensor” of the intangibles, the Spanish investors were also taking steps to have Gatetown own the intangibles. In an October 22, 1986, letter from Harris, the United Kingdom accountants, to “The Directors, Gatetown Limited, Euritor”, Harris stated their understanding of the current situation and the proposed steps to be taken with regard to the setting up of the trading operation of Gatetown Limited in the United Kingdom. The letter included the following information: An “NV” Corporation exists with 20% of that Corporation being owned by Spanish individuals and 80% by 7 “armslength” “NV” Companies. * * * Gatetown Limited has agreed to buy the United States and Canadian copyright and Royalties from a Spanish Corporation in respect of - 36 ”Medieval Times” and this purchase will be financed by loans from the 7 “NV” Corporations. The letter also noted that the two shares of Gatetown stock had been increased to 100 shares with 50 each being held by Mayol and de Oteyza. Jon Edwin Hokanson (Hokanson) was an intellectual property specialist with the law firm of Lyon & Lyon (LL) in Los Angeles. Hokanson was drafting licensing agreements between Manver and MTNV for the use of the intangibles. At this time, however, it was still uncertain who would "own" the intangibles that were being licensed. Hokanson spoke with Forsyth on November 7, 1986, regarding the licensing agreement. In a letter to Forsyth dated November 11, 1986, Hokanson enclosed a new draft of the licensing agreement. The new draft expanded the scope of services provided to the licensee to include the right of the licensee to engage in a business system, in addition to the right of the licensee to use the servicemark. Hokanson believed that the transaction fell within the California Franchise Law, and he had already advised A. Gelabert of that opinion. Hokanson stated that he was forwarding a copy of the revised licensing agreement to A. Gelabert. In addition to Hokanson, Forsyth spoke to Santandreu on November 7, 1986. In a November draft of a letter to Santandreu, Forsyth recapped a November 7, 1986, conversation and supplied further details on the proposed structure of Medieval Times. - 37 Among other items, the letter specifically addressed the choice of entity to own the intangible assets and the question of an appropriate royalty and management fee rate. The letter noted that Manver currently owned the intangibles and should license them to MANV and MTNV for the current year. During the current year, Forsyth believed that only 20 percent of the royalties would be subject to tax. Forsyth suggested that a new licensing structure be implemented once the three-tier system was in place. Forsyth stated in the draft that, as they had previously discussed, a “super royalty” fee could be justified if above-normal profits were due to the nature of the intangible asset. Forsyth discussed the new provisions to section 482 in the 1986 Tax Reform Act, supra, and stated, among other things: To set the appropriate royalty rate would require a detailed analysis of the worth of the intangible asset and the effect of the intangibles on the profitability of the two operating entities. * * * As a working guide, perhaps a rate somewhere between 10-15% would seem reasonable. However, before a rate is decided upon, we will require further consultations with you. It is important in justifying this high rate that the franchise agreement between the owner of the intangibles and the U.S. operating entities detail precisely the distinctive type of restaurant and entertainment services being franchised as the “Medieval Times concept”. We consider that the draft franchise agreement forwarded under cover of Lyon & Lyon’s, Attorneys, letter of November 11, 1986 is appropriate subject to a few general comments. We consider that reference should be made to the script document (as amended), called the “copyright book”, which details the sequence of the performance. In addition, we consider that the agreement should specify some of the services that the licensor shall provide to the licensee. This will include such things as - 38 assistance in the design of costumes and training of horses and actors. Finally, we consider that the license should be an exclusive license for a limited area (e.g. Orange County, California) rather than the nonexclusive license for the whole of the U.S. as is in the current draft agreement. The retention by the licensor of quality control powers, extensive cancellation rights and the right to sublease in the U.S. will assist the argument for a super royalty. These all point to the licensor retaining control of the future marketing, development and profitability of the licensed concept. We consider that the proposed widely worded franchise agreement will restrict the basis on which a management fee may be charged. However, it is still possible to enter into an independent management agreement and to charge a separate management fee. We suggest that such a fee be limited to either a cost plus basis or a relatively low rate, say no more than 2% of gross revenue. We emphasize that the services provided should go beyond the normal stewardship functions that shareholders may exercise. These include ensuring that the information provided to shareholders is adequate and even the selection of senior personnel. The management agreement should emphasize services that a independent management consultant may provide such as detailed advice on: (i) the accounting and administration system; (ii) a financing strategy; and (iii) personnel selection at all levels. We do not recommend charging a separate management fee on top of a “super royalty” under the proposed franchise agreement. However, if you wish to have a separate management fee charged to the U.S. operating companies, we would appreciate the opportunity of reviewing the draft agreement prepared by your attorneys. The draft listed actions that needed to be completed, including actions that needed to be commenced immediately after a November 20, 1986, meeting. The matters that still needed to be - 39 resolved included the ownership of the intangible assets and licensing structure and clarification of the process of transferring the intangible assets to the owner; the royalties and management rates and contents of the supporting agreements; and the method by which it was intended to repatriate the “royalty” income to the beneficial owners of intangible assets, who C&L understood were largely Spanish residents. Louis deVries (deVries) was working with Medieval Times at the C&L office in The Netherlands. deVries met with Santandreu and Onate on November 19 and 20, 1986. At the meeting, they discussed the “draft version of Ian Forsyth’s letter”. Santandreu and Onate had specific questions about certain items in the letter. Santandreu was of the opinion that the suggested 10- to 15-percent royalty rate discussed in the draft letter should be calculated on gross income. On December 9, 1986, Forsyth sent to deVries a memorandum stating that C&L and Medieval Times had decided to use Manver to hold the intangibles and to go ahead and try to get a tax ruling for Manver from the Netherlands Antilles. Forsyth promised deVries that he would forward a timetable of all of the actions to be taken on behalf of Medieval Times in the next few days. On December 11, 1986, the C&L office in the Netherlands Antilles sent a letter to the Netherlands Antilles Inspector of Taxes. The letter stated that Manver was going to be receiving royalties from two NV companies that were operating amusement - 40 parks in the United States. C&L wanted a ruling that only 20 percent of the royalties paid to Manver would be subject to tax. C&L received the favorable ruling on Manver on January 13, 1987. On December 12, 1986, C&L received documents from Medieval Times for the first time. The documents represented, among other things, that the Medieval Times organization was a franchise. Onate sent copies of six documents to Forsyth, only one of which was signed. The first document, dated January 20, 1983, purported to create a joint venture between Eurotor and TM. Although it discussed payments to be received from MTNV, MTNV was not a party to the agreement. The stated purpose of the agreement was to join TM and Eurotor together with the object of providing to MTNV: the right to use the FORMULA created to put in motion and exploit the DINNER-SHOW and TOURNAMENT, THAT IS DEVELOPED IN A MEDIEVAL ATMOSPHERE, for such end, the necessary information will be ceded to MEDIEVAL [MTNV] for the organization, ambientation and launching, through an operations manual in which all will be duly detailed, likewise the orientations and consultations that might proceed the construction of the castle where the FORMULA will be promoted, administered and managed. The document initially established the same fee arrangement as in the January 24, 1983, contract that Allen drafted, 2 percent of the total estimated cost of the facility during the creation and development stages (for a total of 4 percent) and 50 cents per client when the castle is operational. The document - 41 provided for payment by MTNV to Eurotor and TM jointly “but it will be exclusively EUROTOR that will have the rights to them during the entire time that this contract might last”. The document then varied from the January 24, 1983, document in that it further stated that, once MTNV had “achieved a daily average, in the last fiscal year, of 700 clients”, Eurotor and TM would separate, “nullifying, with all effects, their merger.” After the separation, TM was to receive from MTNV 10 percent of MTNV’s “gross production”. TM was to take “exclusive charge of technical assistance, not management.” TM was to contribute to MTNV the use of the name, trademark, and idea; the handbook or formula; all of its experience with respect to choreography, lights, and sound; the making and maintaining of the costumes and wardrobe; all that is relevant to the equestrian section of the program; all that is relevant to the fights, duels, and selection and control of the weapons; its knowledge with respect to the serving of food and drink (catering); an assessment with respect to the promotions and publicity; and effect a “persual [sic]” and control of quality and advise on the modifications that ought to be carried out to which MTNV would always be heedful. Eurotor was to contribute to MTNV its “experience in the management of companies”, including finance, administration, and personnel. The document further stated: “By express desire of EUROTOR and TORNEOS [TM], it is put in evidence that TORNEOS [TM] is the exclusive owner of this FORMULA, that in other countries - 42 is named Franchising.” The document listed Santandreu as the representative for Eurotor and J. Montaner as the representative for TM. The second document was a copy of the January 24, 1983, contract that Allen drafted, discussed earlier. It was the only signed document. The third document was dated February 1, 1983, and titled “CONTRACT BETWEEN TORNEO MEDIEVALES S.A. AND MEDIEVAL TIMES N.V.” This document purported to bind MTNV to the 10 percent of gross production to which Eurotor and TM agreed in the January 20, 1983, agreement. It provided for TM to license to MTNV, for a period of 5 years beginning February 1, 1983, “that the latter may use the name of MEDIEVAL TIMES, trademark, idea, guide and operations manual, which are the property of TORNEOS [TM] in the territory of the United States of America and Canada, of the DINNER SHOW, OF A MEDIEVAL THEME WITH TOURNAMENTS OF THE SAME PERIOD, (herein called ‘FORMULA’)”. MTNV would be required to pay to TM 10 percent of its gross income beginning when MTNV reached a daily average of 700 clients per day, as set forth in the January 20, 1983, joint venture agreement between TM and Eurotor. TM was to assist MTNV with choreography, design and upkeep of the costumes and accessories, the equestrian part of the show, fights and duels and selection and control of the weapons, and catering (system of preparing and serving meals). TM was also to be responsible for - 43 quality control. MTNV “promises to respect all the rules and standards registered in the FORMULA (and operations manual) of which it will have received the relevant copy from TORNEOS [TM]”. J. Montaner was listed as the representative for TM and A. Gelabert as the representative for MTNV. The fourth document was dated May 26, 1986, and was an agreement between Manver and TM whereby TM “is the owner of the Idea, the name MEDIEVAL TIMES, Trademark, Guide and Operations Manual of the DINNER-SHOW, OF A MEDIEVAL THEME WITH TOURNAMENTS OF THE SAME PERIOD, (hereinafter ‘FORMULA’)”. The document referred to the February 1, 1983, agreement between TM and MTNV and stated that, as of the date of this agreement, May 26, 1986, the 700-client per day average had not yet been reached. It further recited: [TM] acquired great and grave responsibilities with respect to the services loaned for the granting of the LICENSE to MEDIEVAL TIMES N.V. and in view of the growth of MEDIEVAL TIMES N.V. and through the pertinent studies, the following conclusions have been reached that a. by its own means it will be impossible [for TM] to comply with its obligations of the contract, if this should occur. b. obtaining these means through a third party would be highly costly and will produce little profit. 7. Whereas considering the aforestated the decision has been taken to SELL to MANVER all the rights of the FORMULA, in the territory of the United States of America and Canada. - 44 As of January 1, 1988, Manver was to pay to TM 1,000,000 pesetas. TM was to “deliver, authentically, the name, trademark and hand-book of the FORMULA to MANVER, in the act of signing this contract.” The contract was not signed. The representatives were J. Montaner for TM and Mayol for Manver, and the parties were to have been assembled in Alfaz del Pi, Spain. The fifth and sixth documents were purportedly management contracts between Eurotor and MANV and Eurotor and MTNV, respectively. The Eurotor and MTNV document was dated August 1, 1986, and named Sans as the representative for MTNV and Santandreu for Eurotor. It stated that, as of July 31, 1986, the joint venture between Eurotor and TM (the January 20, 1983, agreement) was terminated. The document referred to the January 24, 1983, management agreement between Eurotor and MTNV that was drafted by Allen and stated that the management assessment provided to MTNV by Eurotor continues to be “essential” to MTNV. MTNV agreed to pay to Eurotor, effective August 1, 1986, for a period of 1 year, 2 percent of its gross production. Eurotor was to provide, among other things, assessment on finance, administration, marketing, licensing and franchising, personnel, and budgets. These services, allegedly provided under the January 24, 1983, management agreement, were the same services Forsyth specified in his November 1986 draft letter to Santandreu. - 45 The management agreement between Eurotor and MANV was dated February 1, 1986, and named as representatives A. Gelabert for MANV and Segui for Eurotor. It did not mention any of the other agreements but provided for the same arrangement, i.e., 2 percent of gross production with a 1-year duration. The services that Eurotor was to provide were the same as in the agreement with MTNV. There were additional documents related to TM, Eurotor, Gatetown, and Manver that were dated 1986 but not provided to C&L in 1986. There were also documents dated 1986 that were actually drafted sometime during 1987 and later. Two documents, both in Spanish, reflect a sale by TM to Gatetown of the Medieval Times formula. TM was to deliver, pursuant to the sale, the name, trademark, and handbook of the formula to Gatetown. The two documents are virtually identical in language and terms, and both are dated March 1, 1986. The only difference is that one document reflects a sales price of $7,312 and is signed by Mayol for Manver and by J. Montaner for TM. The other document reflects a sales price of 3,000,000 pesetas (approximately $26,000) and was not signed. The language in both documents, except for the sales price, was the same language in the document provided to C&L on December 12, 1986, that purported to represent a sale of the Medieval Times formula from TM to Manver for 1,000,000 pesetas. - 46 An unsigned letter dated March 1, 1986, notified MTNV that TM had sold its rights to the Medieval Times formula to Gatetown. The letter was addressed to the attention of A. Gelabert. Two letters dated May 27, 1986, on Manver stationery, notified MTNV that Manver had purchased the rights to the Medieval Times formula. Both letters referred to the document between MTNV and TM dated February 1, 1983. One letter, addressed to Sans, was in Spanish and informed MTNV that Manver purchased the formula from TM. Manver. It was signed by Mayol for The other letter, addressed to Sans, was in English and informed MTNV that Manver purchased the formula from Gatetown. It was signed by Mayol for Manver and by Sans for MTNV. A Bill of Sale, dated May 27, 1986, purports to represent a sale from Gatetown to Manver of all the rights to the “patent, trademark, copy right, trade secret, contracts, * * * including the goodwill, services, production, advertising, distribution, marks, ideas, concept, operations manuals, show scripts, and the name MEDIEVAL TIMES, which are identified by the marks ‘MEDIEVAL TIMES’ and ‘MEDIEVAL TIMES WITH DESIGN’.” The sale was in consideration of 200 shares of stock and an obligation to pay $3.8 million (U.S. dollars) for a total value of $5.6 million. The $3.8 million was to be paid in five annual installments of $760,000 each, with the first payment commencing on June 1, 1987. The document was signed by Mayol for Gatetown and by Nouel (an attorney at CANV) for Manver. - 47 An annex to the Bill of Sale between Gatetown and Manver provided that the annual installments of $760,000 beginning June 1, 1987, should have added to them simple interest of 9 percent per year payable monthly on the outstanding balance. The document was dated June 30, 1986, and was signed by Mayol for Gatetown and by Onate for Manver. An agreement dated July 25, 1986, between Eurotor and MTNV purported to amend the January 20, 1983, document notwithstanding that MTNV was not a party to the January 20, 1983, document. The original construction on the castle had been completed prior to the castle’s opening in December 1983, 2-l/2 years before July 1986. The amendment was allegedly necessary because “the scheduled time to finish the constitution [sic] was delayed for about six months or more. The two parties agree that because of the reasons mentioned above instead of an accrued 4% as seen in the agreement signed of 1/20/83, it would be 10% (ten) of the total estimated cost of the facility.” The agreement was signed by Sans for MTNV and by Santandreu for Eurotor. Manver purportedly entered into licensing agreements with MTNV and MANV in 1986. Both documents granted the licensees (MANV and MTNV) the exclusive right to use the licensed services described as “the Licensed Servicemarks and the Distinctive Services in connection with the sale, offering for sale and advertising of restaurant and entertainment services using the Distinctive Services”. Both documents required that the - 48 licensees pay to Manver a royalty fee equal to a percentage of the total gross sales derived from the services listed thereunder, with the percentage established as 10 percent for the first year, 12.5 percent for the second year, and 15 percent for each year thereafter. The percentages were within the range suggested by Forsyth in the November 1986 draft letter. The draft letter was prepared several months after the date placed on the licensing agreements. The agreements were for a duration of 5 years. The MANV licensing agreement was dated May 27, 1986, with payments beginning November 30, 1987. The MTNV licensing agreement was dated August 1, 1986, with payments beginning July 31, 1987. Both documents stated: “The first payment is due 183 days after commencement of operations by LICENSEE.” The MTNV agreement was signed by Mayol for Manver, Sans for MTNV, and Watson as a witness. Watson dated his signature March 30, 1987. The MANV agreement was signed by Mayol for Manver and by A. Gelabert for MANV. The language in both of the documents was substantially identical to the language in the draft of a licensing agreement prepared by Hokanson and forwarded to Forsyth on November 11, 1986, which was several months after the date of the licensing agreements. The differences between Hokanson’s drafts and these two licensing agreements were the parties’ names, dates, and payment terms. Gatetown’s stock was held by de Oteyza and Mayol into 1987. - 49 Futureprom, N.V. (Futureprom), was a Netherlands Antilles entity incorporated on or about June 10, 1982. On June 10, 1987, Onate sent a letter to Sans requesting that Sans check to see if Allen had the share certificates and articles for Futureprom. On August 17, 1987, the two shares of Gatetown were transferred from de Oteyza and Mayol to Lince and Futureprom. Lince and Futureprom each received one of the two Gatetown shares. On the same date, de Oteyza resigned as a director of Gatetown and was replaced by Onate. After de Oteyza and Mayol transferred their stock, the owners of Gatetown, through their ownership of Lince and Futureprom stock, were Attractours (J. Montaner), Dapy (Kahne), Holiday (Segui), Roundabout (Santandreu), Spectrust (Valiente), Wayout (Climent), Promidux (P. Montaner), Primavert (Santandreu), and Chavez. Harris sent correspondence to "HM Inspector of Taxes" in London that detailed Gatetown’s activities. Among the documents were the Bill of Sale from Gatetown to Manver of the rights to the Medieval Times concept and the annex that added the interest payment. Three additional documents were enclosed. The documents attempted to bind Gatetown to pay 95 percent of the payments it received from Manver to Lince and Futureprom. The first agreement stated: In consideration of the receipt of 10.968 dolars, being an unsecured loan, with no interest or fixed repayment date, GATETOWN LIMITED, the borrower agrees to pay FUTUREPROM, N.V., the lender, 95% (ninety-five) of any future royalties, franchise fees, sale proceeds or any - 50 other income or interest whatsoever arising from the purchase by GATETOWN LIMITED of the rights to TORNEOS MEDIEVALES, S.A. OF ALL PATENT, TRADEMARK, COPYRIGHT, * * * INCLUDING THE GOODWILL, SERVICES, PRODUCTION, ADVERTISING, DISTRIBUTION, MARKS, IDEAS, CONCEPT, OPERATION MANUALS, SHOW SCRIPTS AND THE NAME MEDIEVAL TIMES, WHICH ARE IDENTIFIED BY THE MARKS “MEDIEVAL TIMES” AND “MEDIEVAL TIMES WITH DESIGN”, which it [Gatetown] has today purchased by the assistance of the above mentioned loan from * * * [FUTUREPROM]. The document was dated February 26, 1986, and was signed by Mayol for Gatetown and by Nouel of CANV for Futureprom. The second document was almost identical to the first document except that the loan was from Lince to Gatetown for “21.936$ dolars”. same. The remaining terms and conditions were the It was dated February 26, 1986, 3 months before Lince was incorporated. It was signed by Mayol for Gatetown and by Segui for Lince. The third document referenced the first and second documents and provided that, in consideration of the loans provided to Gatetown by Lince and Futureprom whereby Gatetown agreed to pay 95 percent of any royalties, franchise fees, etc., to Lince and Futureprom, Gatetown was now agreeing to pay to Lince 95 percent of all of the income received from Medieval Attractions, N.V. (Buena Park, U.S.A.), and to pay to Futureprom 95 percent of all of the income received from Medieval Times, N.V. (Kissimmee, U.S.A.). The document was signed by Segui for Lince and by Nouel for Futureprom. It was dated June 1, 1986. - 51 Gatetown's existence was reflected in other documents maintained by Harris, including a copy of the Spanish version of the agreement whereby TM sold its rights to the Medieval Times concept to Gatetown for 3,000,000 pesetas. The “loans” from Lince and Futureprom totaled $32,904. Another document in Harris’ possession was titled “Gatetown Limited Accounts for the Period Ended 30th April 1988". That document contained the following: PRINCIPAL ACTIVITY AND BUSINESS REVIEW The principal activity of the Company is that of owners of royalty and copyright agreements. The Company acquired the rights to certain trade marks, patents etc. which were transferred and assigned to the Subsidiary Company [Manver] in exchange for the entire issued Share Capital (the Subsidiary Company not having any assets or liabilities previously) in addition to an obligation to pay to the Company $760,000 each year for 5 years. The Company is under obligation to its two shareholders Futureprom N.V. and Lima [sic] N.V. to pay 95% of its income to the two Companies. The Company has had a satisfactory year and looks forward to the future with confidence. The document listed as Gatetown’s 1988 assets: $1.8 million as “Investment in Subsidiary” and $3,131,200 as “Amounts owed by Subsidiary Company”. The October 8, 1990, letter from Harris to "HM Inspector of Taxes" included the following information on royalty payments by Gatetown: - 52 1988 Futureprom N.V. Lince N.V. $ 786,085 1,172,763 1989 $1,678,138 3,735,209 Manver International, C.V. (MICV), and Manver Global, B.V., were incorporated in 1990. Santandreu and Onate were members of MICV’s Executive Committee. Lince and Futureprom each owned 48.5 percent of MICV stock. A document dated October 17, 1990, purported to transfer from Manver to MICV: all world wide rights to the intellectual property and franchising rights with respect to the idea, concept and Operating Manuals concerning a Dinner and Tournament Show Restaurant in medieval style and/or villa’s Medieval style under the names “Medieval Times” and/or “Medieval Life”, and all related rights including but not limited to trademarks, tradenames, copyrights, goodwill, licenses and physical ownership of documents embodying any right of intellectual property and franchising rights etc., hereinafter referred to as “The Intellectual Property” * * * In consideration of the sale, MICV agreed to pay to Manver $64.1 million by “way of two promissory notes which will be issued upon signature of this agreement.” The document was signed by Onate for Manver and by Santandreu for MICV. Subsequently, a 1990 financial statement for MICV reflected a $64.1-million note payable. In 1991, the $64.1 million was reflected as capital stock. VI. Trademarks and Copyrights In December 1982, Castro filed an application for a post office box in Kissimmee, Florida, in the name of Medieval Times. The name Medieval Times had not been used previously in the - 53 United States or Spain. In December 1983, A. Gelabert filed an application for a business license with the State of Florida. The business name on the application was Medieval Times. From 1983 to 1987, the Medieval Times trademark and logo continued to evolve and the stationery and business cards bore different lettering styles and designs. The Rocaberti shield was used in some instances, and, in other instances, a picture of a castle was used on stationery. Hokanson, at LL, performed trademark and copyright registration work for the Medieval Times companies in 1986 and 1987. Originally, MANV was identified as the client. Invoices for LL’s services on October 24, 1986, and May 22, 1987, were sent to MANV in Buena Park, California. Hokanson relied on the information provided to him by A. Gelabert, Forsyth, Santandreu, and Onate with regard to the ownership of the trademark. Hokanson made no independent inquiries into the ownership of the trademarks. A letter dated October 17, 1986, from A. Gelabert to Hokanson stated: “Names of corporation which will register the trademark of Medieval Times will be GATETOWN LTD. (Limited), incorporated in England on June 22, 1985.” LL filed to register the marks “Medieval Times” and “Medieval Times with Design” in California and Florida in February 1987. The Medieval Times mark consisted of the words “Medieval Times”. The Medieval Times with design mark consisted - 54 of the words “Medieval Times” and the Rocaberti shield. The California marks were successfully registered in California in May and October 1987. The Florida marks were successfully registered in March 1987. The applications for California and Florida named Manver as the applicant. LL applied to register the marks with the U.S. Patent and Trademark Office in September 1987. The marks were successfully registered in November and December 1988. Manver as the applicant. The applications named In January 1989, Onate sent a letter to Sans stating that the new registered marks should be included on all documents printed in the future. In February 1989, Sans informed Bellows about the requirement to include the registered marks on all future printing. II. Section 351 Transfers As part of the plan to restructure the Medieval Times companies, C&L prepared a valuation of the tangible and intangible assets of Medieval Times. As of January 31, 1987, C&L concluded that the fair market value of MANV’s assets was $6,174,800 and the value of MTNV’s assets was $4,358,380. The amount of fair market value attributed to goodwill was $5,582,577 for MANV and $3,670,936 for MTNV. The valuation reports stated: Goodwill is defined as that favorable disposition which customers entertain toward a particular enterprise which may induce them to continue giving their patronage to it. The existence of goodwill of an enterprise is evidenced by earnings in excess of those normally encountered in that company’s particular industry. - 55 Information about the valuations was provided to A. Gelabert in letters dated March 1987. The letters also stated: We define fair market value as the price at which property is exchanged between a willing buyer and a willing seller, neither being under compulsion to act and both having reasonable knowledge of relevant facts and market conditions. Our estimate of fair market value does not reflect synergies and efficiencies that a specific buyer may contribute. In a November 16, 1987, letter, C&L advised A. Gelabert that the fair market value of MANV as of September 30, 1987, had increased to $14 million. C&L valued MANV goodwill as of September 30, 1987, at $13,696,767. The companies that C&L used as comparables in its valuation included TGI Friday’s, Inc.; International King’s Table; Jerrico; and Vicorp. MSI was incorporated in Florida by Allen on January 20, 1987. MDT was incorporated in California on or about August 3, 1987. MSI and MDT were going to be the U.S. operating companies as required by the C&L plan for a three-tier corporate structure for the Medieval Times companies. MABV and Medieval Times, B.V. (MTBV), were incorporated in The Netherlands on September 29, 1987, and July 31, 1987, respectively. MABV and MTBV were to be the middle tier in the three-tier structure proposed by C&L. Throughout 1987 and until December 12, 1988, the various C&L offices involved in implementing the three-tier restructuring plan corresponded with drafts of agreements, promissory notes, and timetables in anticipation of the section 351 transfers. In - 56 July 1988, C&L Amsterdam sent to Forsyth drafts of promissory notes that were dated 1987. The correspondence was dominated by discussions on tax rulings from the Netherlands Antilles. Randolph M. Th. de Cuba of C&L sent letters dated September 30, 1988, to the Inspector of Taxes in the Netherlands Antilles requesting tax rulings on behalf of Manver, MTNV, and MANV. C&L wanted rulings for Manver on the tax treatment of royalties, income, and whether or not interest would be imputed on non-interest-bearing loans. The ruling requests for MANV and MTNV concerned income, dividend income from MABV, and whether or not interest would be imputed on non-interest-bearing loans. The letters also provided that Manver held the shares of MANV and MTNV, that MANV held all of the shares of MABV, and that MTNV held all of the shares of MTBV. C&L received the rulings it desired from the Inspector of Taxes on October 6, 1988. The Inspector of Taxes agreed, among other things, that interest would not be imputed on the specified noninterest-bearing loans. Some of the documents that purported to effectuate the section 351 transfers were executed no earlier than late 1988, although they were dated 1987. The documents for the Florida side of the double section 351 transactions were dated August 1, 1987, one day after incorporation of MTBV. The documents provided that, on that date, MTNV ceased doing business and transferred its assets and business, subject to its liabilities, - 57 to MTBV for a total consideration of $4.4 million (U.S.). Of this amount, 1.723 million Dutch Guilders was paid in stock of MTBV, 1.953 million Dutch Guilders was paid in an interest-bearing note, and $2.64 million (U.S.) was paid in a non-interest-bearing note. The 1.953 million Dutch Guilders note was payable in 10 years upon presentation of the note. The interest was payable on the Dutch Guilders note quarterly at a rate of 9.5 percent, with the principal due in 10 years upon presentation of the note. The non-interest-bearing $2.64 million loan was “payable in ten years on presentation of this promissory note”. MTBV immediately transferred the assets and business it received from MTNV to MSI for a total consideration of $4.4 million. Of the $4.4 million, $1.1 million was paid with MSI stock and $3.3 million was paid with a negotiable interestbearing promissory note. The terms of the promissory notes varied among the drafts from 5 years to 10 years. Interest at a rate of 9.5 percent was to be paid quarterly, with the principal due at the end of the term of the note. The documents for the California side of the double section 351 transaction were dated December 1, 1987. The documents recited that, on that date, MANV ceased doing business and transferred its assets and business, subject to liabilities, to MABV for a total consideration of $14 million (U.S.). Of the $14 million, 4,879,875 Dutch Guilders was paid in stock of MABV. - 58 MABV issued an interest-bearing note in the amount of 5,530,525 Dutch Guilders with 9.5-percent interest due quarterly and the principal due in 10 years on presentation of the promissory note. MABV also issued a non-interest-bearing note for $8.4 million (U.S.) that was payable in 10 years upon presentation of the note. MABV immediately transferred the assets it received from MANV to MDT for a total consideration of $14 million. Of this amount, $3.5 million was paid with MDT stock and $10.5 million was paid with an interest-bearing note. note had a rate of 10 percent. The interest-bearing The interest was due quarterly, and the principal was due in 5 years. After the section 351 transfers, MTNV held all the stock of MTBV, which held all the stock of MSI. MANV held all the stock of MABV, which held all the stock of MDT. The C&L September 30, 1988, letter to the Inspector of Taxes stated that Manver held all the shares of both MANV and MTNV. MSI and MDT signed licensing contracts with Manver that were substantially the same as the Manver-MTNV/MANV contracts. The MSI and MDT documents were dated August 1, 1987, and December 1, 1987, respectively. MSI and MDT signed new management contracts with Eurotor dated August 1, 1987, and December 1, 1987, respectively. - 59 VIII. California and New Jersey Expansion A. California The Medieval Times group began to expand its operations. On December 15, 1987, Glendale Castle, Inc. (GCI), was incorporated in California. GCI filed 1987 (fiscal year December 23, 1987, to November 30, 1988) and 1988 Federal tax returns that stated that GCI was an inactive corporation. GCI’s articles were amended on December 13, 1988, to change the name of GCI to the San Diego Castle, Inc. (SDCI). The amendment stated that it had been approved by the board of directors. In December 1988, GCI/SDCI entered into a lease, signed by A. Gelabert, for vacant land in Carlsbad, California. A. Gelabert also signed papers in the name of GCI/SDCI on an application for a change of zoning to accommodate the new castle facility and on an agreement for the payment of a public utilities fee. MDT maintained an account entitled “Advances - San Diego Castle”. The first entry was June 15, 1988, and the last entry was November 30, 1990. The expenses included payments to the City of Carlsbad, C&L, an engineering company, and marketing fees to RC. MDT deducted these expenses on its Federal tax returns in the amounts of $18,633 and $128,775 in 1988 and 1989, respectively. In December 1989, after the Carlsbad Planning Commission denied GCI/SDCI’s project because of traffic problems, GCI/SDCI withdrew its application from the planning commission. A - 60 planning commission letter dated December 14, 1989, accepted the withdrawal. The letter also listed previous actions related to the application, including that the commission had passed a motion on October 18, 1989, to discuss the traffic issues associated with the application. After the December 14, 1989, letter, Taylor, with Santandreu’s knowledge, continued to look for sites in San Diego on which to build a castle. A document entitled “Resolution of the Board of Directors of Medieval Dinner & Tournament, Inc.” resolved that the corporation (MDT) immediately abandon the Carlsbad project “considering the fact that the corporation failed to get the necessary approval by the Carlsbad Planning Commission”. It was dated October 17, 1989, Palma de Mallorca (Spain), and was signed by Santandreu, A. Gelabert, Segui, P. Montaner, Kahne, and Climent. B. New Jersey In December 1987, Meadowlands Castle Inc. (MCI) was incorporated in New Jersey for the purpose of opening a castle in New Jersey. MCI retained a New Jersey law firm to represent it before various city, county, and State authorities. By this time, Watson was working for the Medieval Times companies and had an ownership interest in MANV through Estaspan. New Jersey to assist with the development. Watson went to He opened bank accounts at National Community Bank (NCB) in New Jersey in MCI’s name; made a presentation to the City Council of Lyndhurst, New Jersey; and negotiated with a landlord for a lease in the name of - 61 MCI. On July 20, 1988, A. Gelabert directed the Australia and New Zealand Bank (ANZ Bank) to transfer $45,000 from the "Wayout dividend account" to MCI’s account at MCI’s New Jersey bank. had several accounts at NCB. MCI MDT transferred money to MCI accounts, including a $100,000 transfer on April 12, 1988, and a $127,000 transfer on September 15, 1988. MCI maintained an insurance policy in its name. In September 1988, Watson, on behalf of MCI, obtained a letter of credit from ANZ Bank for $325,000. In December 1988, Santandreu, A. Gelabert, Segui, P. Montaner, Kahne, and Climent were elected to the board of directors of MCI. On March 20, 1989, A. Gelabert, as MCI president, signed a construction contract to build the New Jersey castle. The New Jersey castle was subsequently built with funds supplied by MDT. Various contracts, invoices, and correspondence continued to use the name MCI after March 20, 1989. C. C&L Advice In a letter to Santandreu dated August 31, 1988, C&L responded to Santandreu’s questions about equity contributions to MCI. The letter stated that MCI would be owned 87 percent by MDT and 13 percent by minority shareholders. The letter further stated: Instead of discussing ways to make equity contributions by respective shareholders, this letter discusses the merits of operating new castles as divisions of MDT rather than separate subsidiaries, at least until the operation at each castle commences. - 62 ISSUE Can MDT currently deduct the pre-operating expenditures incurred for the Glendale and Meadowlands castles and amortize under IRC Section 1253(d)(2) the franchise rights it acquired from Manver, N.V. (MNV) before the operation at each castle commences? C&L's letter recited several facts, including: MDT entered into a contract with Manver to amortize franchise rights for MDT, GCI/SDCI, and MCI; GCI/SDCI and MCI were both incorporated in December 1987 to operate castles; GCI/SDCI and MCI were both currently negotiating leases for land to build castles; MCI had already incurred $200,000 in startup expenses, which were paid with advances from MDT and contributions of capital from 13 minority shareholders; it was expected that both sites would incur substantial additional preoperating expenses; and MDT was planning to contribute its capital share (87 percent of $1.5 million) to MCI in the near future. The letter continued with an assessment of various Internal Revenue Code sections and case law. It pointed out that costs incurred before the actual commencement of a trade or business (i.e., startup costs) are "clearly not deductible since such expenses are not incurred in 'carrying on a trade or business' under IRC section 162." However, it noted that expansion costs incurred by an ongoing business enterprise are incurred in "carrying on a trade or business" under section 162 and will therefore be currently deductible as long as they are not capital expenditures. - 63 With regard to the deduction for the amortization expense, C&L noted that, for the deduction to be taken, the transferee of a franchise must also be conducting a trade or business. It explained that the trade or business requirement allows deductions for expenses incurred only when business operations commence and activities for which the trade or business was formed are performed. C&L stated that there was an issue as to whether or not a trade or business existed with respect to MCI and GCI/SDCI because the actual operations of the castles would not commence for at least a year. C&L addressed a resolution for both issues and stated: However, if we assume that both MC [MCI] and GC [GCI/SDCI] can be operated as divisions of MDT instead of separate subsidiaries, an argument can be made for amortizing the franchise rights before the commencement of operations at MC and GC. It can be argued that MDT acquired the additional franchise rights in order to expand into other territories and as such the amortization of the additional franchise rights are "ordinary and necessary" expansion costs incurred by an ongoing business enterprise in "carrying on a trade or business." C&L concluded that “there appears to be relatively strong support for deducting pre-operating expenses at MC [MCI] and GC [GCI] and amortizing the franchise rights for the Glendale and Meadowlands sites as long as both castles are operated as divisions of MDT, not as separate subsidiaries.” C&L recommended a number of actions, which included: Operate the two additional castles as divisions of MDT and delay equity contributions to MC [MCI] and GC [GCI] until after the operation commences at each location. - 64 Andres Gelabert indicated that the minority shareholders would have no objection to this idea. * * * * * * * * * * Do not treat any of the monies spent already as either advances to or equity contributions to MC [MCI] or GC [GCI]. Instead, MDT should treat its advances or potential equity contributions as divisional expenditures and the “equity” contributions from the minority shareholders, if needed, should instead be treated as loans to MDT which, in turn, were used in the divisional projects. IX. Dividends MTNV paid dividends from the 1983 through 1985 profits on January 27, 1986, and May 1, 1986. The payments consisted of the following: Spectrust Promidux Dapy Roundabout Holiday Wayout Alfonso Chavez Gloria Chavez $ 31,070.42 45,676.99 45,674.67 29,413.55 29,413.55 25,892.41 12,946.21 12,946.20 $233,034.00 The payments were approximately in proportion to each payee’s ownership interest in MTNV. MTNV paid dividends on 1986 profits on October 7, 1986, in the following amounts: - 65 Spectrust Promidux Dapy Attractours Roundabout Holiday Wayout Gerard Chavez Alfonso Chavez Gloria Chavez $ 82,200.95 80,151.01 80,151.01 81,830.97 77,817.47 77,817.47 68,501.82 12,331.56 28,085.13 28,085.13 $616,972.52 The payments were approximately in proportion to each payee’s ownership interest in MTNV. A. Gelabert, as managing director of MTNV, directed Sans, in a letter dated June 17, 1987, to pay additional dividends. The dividends were paid in June 1987 as follows: Spectrust Promidux P. Montaner Dapy Kahne Roundabout Roundabout Santandreu Holiday Holiday Segui Wayout Attractours Gerard Chavez Alfonso Chavez Gloria Chavez $ 66,665.00 52,502.50 12,250.00 52,502.50 12,250.00 50,610.00 1,055.55 12,250.00 50,610.00 1,055.55 12,250.00 55,555.00 66,000.00 9,800.88 22,321.51 22,321.51 $500,000.00 The payments were approximately in proportion to each payee’s ownership interest in MTNV. dividends paid by MTNV. The 1987 dividends were the last No dividends were paid by MSI from incorporation through at least 1991. - 66 MANV paid dividends once, during the fiscal year ended November 30, 1987. The dividends totaled $2.5 million. No dividends were paid by MDT from incorporation through at least 1991. X. Marketing Agreement A 1986 C&L letter addressed to Santandreu, marked "September draft", addressed the best method of “structuring the arrangement between A and B so that profits and losses are shared equally and Company A retains the benefit of appreciation in the property.” In the draft letter, C&L pointed out the disadvantages of operating as a partnership and suggested the use of a management agreement: A simpler way to structure the agreement and still accomplish the objectives of the property owner would be for MANV to retain ownership of the property and contract with MTNV to manage the project. Under this approach, if profits and losses are shared equally by the two companies, the possibility exists however, that the Internal Revenue Service could determine that the arrangement is actually a joint venture taxable as a partnership. Thus, extra care would need to be taken in drafting the management agreement. For example, a management agreement between MANV and MTNV could be drafted allowing the compensation of MTNV to be based on a percentage of gross receipts, or a percentage of net cash flow (i.e. gross receipts less operating expenses). Depreciation and amortization would thus be allocated entirely to MANV as property owner. In 1989, an agreement between MANV and MTNV dated March 4, 1986, was sent to MSI. The agreement was structured in accordance with the advice that C&L rendered to the Spanish investors in October 1986 and required MANV to pay to MTNV 10 percent of MANV’s profits after taxes during MANV’s 1986 - 67 fiscal year. The agreement stated that the payment was to be paid in return for services that MTNV provided to MANV regarding the: technique in marketing, promotion and publicity of a dinner tournament business, and for taking its representation to assist in fairs, conventions and other mass meetings relating to the business of M.A. [MANV], with enough powers and authorization to contract in the name of M.A., travel agency groups, company groups and others, always under the economical conditions marketed by M.A. The payment was to be due “not later than one year after the filing by M.A. [MANV] of its 1986/1987 Tax Return to the Internal Revenue Service in the USA.” MANV filed its 1986 Federal tax return on June 7, 1988. A fax cover sheet dated June 22, 1989, from Onate to Bertha Moreno at MANV/MDT stated: “We are faxing you the Agreement regarding the invoice of US $236,313.30 for Marketing Consulting between Medieval Times and Medieval Attractions.” Onate sent to Mary Ann Powell at MDT/MANV a letter dated July 3, 1989, in which Onate enclosed a copy of the marketing agreement for her files. MDT/MANV paid to MSI/MTNV $236,313.30 by check dated July 3, 1989. The check reflected an amount equal to 10 percent of MDT’s profits after taxes as stated on MDT’s fiscal year 1986 (December 1, 1986, to November 30, 1987) Federal tax return. XI. Commercial Paper During 1987, the U.S. Treasury Department announced its intention to terminate several of the tax treaties that existed between the United States and the Netherlands Antilles. The - 68 termination would have had an effective date of January 1, 1988. Because the termination would have affected the Medieval Times companies, C&L advised them to consider accelerating any payments that were scheduled to be made to the Netherlands Antilles companies after January 1, 1988. Among the alleged various payments that the Medieval Times companies had to make after January 1, 1988, were amounts under the licensing agreements between Manver and MDT and between Manver and MSI. Pursuant to the Manver-MANV/MDT agreement, MANV had paid Manver $1,441,924 as franchise fees for 1987, but MANV/MDT and MSI purportedly still owed the balance of the contracts to Manver. C&L and Santandreu determined that it would be possible for the licensees (MDT and MSI) to prepay the royalties that were due under the 5-year licensing agreements. The prepayment plan would require the licensees to prepay the royalties in a lump sum up front by financing the prepayment amounts with promissory notes that allowed the licensee to pay interest only for 5 years, with a balloon principal payment due at the end of the 5 years. C&L advised that the lump-sum payment amount would have to represent the discounted present value of the expected royalty stream for the prepayment period. The information about the income stream was provided to C&L by Medieval Times personnel. In addition to the Florida and California lump-sum amounts, lump-sum amounts were determined for the New Jersey and Glendale/San Diego castles, even though these castles were not - 69 operating at the time. C&L used 3-year income streams on the two nonoperating castles instead of the 5-year income streams used on the operating castles. The New Jersey and Glendale/San Diego castle amounts were added to the MDT lump-sum amount for a total of $15.75 million. computed as: The MDT discounted present value amounts were Buena Park, $9.9 million; New Jersey, $3.15 million; and Glendale/San Diego, $2.7 million. lump-sum amount for MSI was $7 million. The Under this plan, MSI and MDT would have collectively given Manver promissory notes for $22.5 million in 1987 and paid interest on the promissory notes monthly. The principal would have been due in 5 years. Under the lump-sum plan, MSI and MDT would have been subject to withholding tax on the interest payments to Manver. C&L therefore suggested that the withholding could be avoided through the use of commercial paper. C&L advised that there was an exemption in the U.S. tax law that excused the withholding tax on interest on promissory notes (commercial paper) with a term of less than 183 days. Forsyth dealt primarily with Santandreu and Onate concerning the commercial paper. The procedure required issuing an initial round of commercial paper (tranche) with a maturity of less than 183 days. Prior to maturity, the tender panel manager must have the cash available to repay the first tranche. The cash could come from a new issue of commercial paper, or, alternatively, the tender panel manager could call on the guarantor or the company - 70 to provide additional funds. Either way, the tender panel manager had to have the cash prior to the maturity of the first tranche to repay that tranche. Forsyth advised that C&L would like a substantial part of the placement made to unrelated parties but that related parties could be investors in the program. Forsyth advised that the guarantors should not purchase the commercial paper directly or indirectly. Forsyth also advised that it would be better for a purchaser holding notes in an expiring round not to purchase notes in the replacement round. Forsyth inquired about how much cash the Spanish investors could provide as part of the commercial paper arrangement. At this time, the Spanish investors had $10 to $20 million in their bank accounts. It was decided that $10 million cash would be provided by the Spanish investors through their controlled Netherlands Antilles corporations. MSI and MDT were to issue commercial paper sufficient to borrow the $10 million, which would be paid to Manver before December 1987. The remaining $12.5 million would be financed by the issuance of promissory notes to Manver. In December 1987, $5 million was transferred from the J. Montaner-controlled entities, primarily Dapy, and $5 million was transferred from the Santandreu-controlled entities, primarily Roundabout, to Gatetown. On December 22, 1987, MSI and MDT issued negotiable commercial paper promissory notes, in $500,000 increments, to five entities to finance the $10-million payment. The five entities were companies controlled - 71 by the Spanish investors: Lince; Protravol; Edemle, N.V. (Edemle); Attractours; and Futureprom. These five companies did not transfer money to MSI or MDT as purchase money for the notes. The commercial paper notes matured June 17, 1988, because, in accordance with C&L’s form, the notes could not have a maturity date over 183 days. On December 29 and 30, 1987, Gatetown transferred $7,136,376 of the $10 million to MDT and $2,854,599 to MSI. On December 29 and 30, 1987, MDT transferred $6.9 million cash and issued three negotiable promissory notes totaling $8.6 million to Manver. MSI transferred $3.1 million cash and issued a negotiable promissory note in the amount of $3.9 million to Manver. After these transactions, Manver had been paid the $22.5 million. The payments consisted of the $10 million cash that originated from the Dapy and Roundabout entities, for which the commercial paper was issued, and $12.5 million in promissory notes. Amendments were drawn up to the MDT/Manver and MSI/Manver licensing agreements to reflect the new lump-sum payment terms. The amendments provided for 10-percent interest on the unpaid balance, interest only payable monthly, and the entire balance due in 5 years. An additional term was added to both amendments that required MDT and MSI to pay to Manver 15 percent of gross sales that were in excess of base amounts set forth in the agreements. The base amounts were: - 72 Year MDT Base MSI Base 1988 1989 1990 1991 1992 $17,800,000 20,000,000 22,300,000 24,500,000 24,500,000 $11,700,000 13,400,000 15,200,000 17,300,000 18,200,000 Santandreu decided to refinance the $12.5-million promissory notes with commercial paper to avoid the withholding, as was accomplished on the $10 million. On March 23 and 24, 1988, Manver deposited $9.03 million with Gatetown. On March 24, 1988, the refinancing was accomplished by the following transactions: Gatetown transferred approximately $4.03 million to Lince, which transferred the same amount to Roundabout; Roundabout transferred $2.673 million to Gatetown; Gatetown transferred approximately $7.672 million to MDT, which then transferred this amount to Manver. Manver started the circle again by transferring $2.672 million to Gatetown, which transferred that sum to Lince. Lince transferred $1.41 million to Primavert, which transferred that sum to Protravol. to Roundabout. Lince transferred another $1.262 million Roundabout then transferred approximately $1.944 million to Protravol. Protravol transferred approximately $3.354 million to Gatetown, which transferred it to MSI, which, in turn, transferred it to Manver. By shifting the funds, which originated with Manver, through the various entities, MSI and MDT used $7.672 million to reduce - 73 the debts to Manver by $11 million. MSI issued $3.5 million and MDT issued $8 million in commercial paper to six entities-Protravol; Attractours; Futureprom; Amsrott, N.V. (Amsrott); Celin, N.V. (Celin); and Slider, N.V. (Slider)--to account for the $11 million paid to Manver, even though none of the six companies provided any of the funds to pay the Manver debt as the funds originated from Manver. The original $10 million that was transferred to Gatetown from Dapy and Roundabout was returned to Dapy and Roundabout in May and June 1988. The first tranche of commercial paper that was issued December 22, 1987, was to mature on June 17, 1988. On that day, $2.391 million was channeled through various entities in order to retire the first tranche of commercial paper totaling $10.5 million. At the same time, another tranche of commercial paper totaling $10 million was issued. As each tranche of funds matured, a new set of transactions occurred that retired the old paper, issued new paper, and paid amounts that were associated with the issuance of the paper, such as Original Issue Discount interest and guarantee fees. The commercial paper carried an interest rate of 1 percent over London Interbank Offered Rate (LIBOR). The interest and guarantee fees were transferred from the controlled entities receiving the payments to the Spanish investors' Eurotor companies in proportion to the Spanish investors' interests in MTNV and MANV. - 74 Dapy and Roundabout acted as guarantors on the commercial paper transactions and received fees for the service. Although the fees were paid to Dapy and Roundabout, the fees were ultimately distributed to the group of Spanish investors. Neither Dapy nor Roundabout was actually required to make a payment as a guarantor. Subsequent tranches of commercial paper were issued on dates including September 17, 1988; December 14, 1988; March 15, 1989; June 11, 1989; September 10, 1989; March 6, 1990; August 30, 1990; November 26, 1990; and later. same type of circular funding. These transfers used the The only differences were the dates, bank accounts, amount of money, and which entities were used. The companies that participated in the commercial paper transactions and the companies that acted as guarantors of the paper were controlled by the Spanish investors. Primarily, Santandreu directed and A. Gelabert and Onate carried out various aspects of the commercial paper transactions. Santandreu owned an interest in a finance company and had been represented by the other Spanish investors to be an expert in international finance. XII. Royalty Transactions Relied Upon in Federal Tax Returns The positions taken by the Medieval Times entities on their Federal tax returns with regard to royalty payments were based on the following series of purported transactions: Gatetown’s purchase of the Medieval Times concept from TM on March 1, 1986, - 75 for $7,312; Manver’s purchase of the Medieval Times concept from Gatetown on May 27, 1986, for $5.6 million; MSI’s right under the Manver license to use the Medieval Times concept from Manver for $7 million on December 22, 1987, and the related commercial paper used to finance the transaction; and MDT’s right under the Manver license to use the Medieval Times concept from Manver for $15.75 million on December 22, 1987, and the related commercial paper used to finance the transaction. XIII. Federal Tax Returns A. MTNV/MSI The MTNV Federal tax returns for fiscal years ended July 30, 1987, and August 1987 (partial year return), and the MSI returns for the fiscal years ended July 31, 1988, and July 31, 1989, were prepared by the C&L Orlando office. Statements attached to the returns indicated that MTNV transferred its assets to MTBV and that MTBV transferred its assets to MSI, in section 351 transactions for stock and securities. The statements reported that all future operations would be reported by MSI. The statements reflected the property received, stock and securities issued, and liabilities assumed: “Medieval Times B.V. has assumed all of the liabilities of Medieval Times, N.V.” - 76 MTNV/MSI reported the following on its Federal tax returns: Royalties/ Franchise Payments FYE July Gross Receipts Total Income Taxable Income 1986 1987 1988 $ 7,048,767 8,880,965 11,338,915 $3,836,276 5,884,314 7,522,728 $ 1989 12,714,857 8,401,603 1,815,541 1990 13,413,711 8,526,965 1,636,788 -888,513 489,190 855,023 1,400,000 15,728 1,400,000 2,696,365 7,710,400 205,292 1,754,155 583,333 1,400,000 636,795 1,308,856 1,485,473 $ 12/31 Calendar Year 1990 1991 4,290,024 11,759,972 MSI deducted as consulting fees to Eurotor: MSI Eurotor 1988 1989 $232,549 $86,341 Included in the 1987 through 1989 returns were additional deductions for management fees and royalty payments to Manver. The 1988 and 1989 returns also contained deductions for debt guarantees, franchise amortization, and interest including Original Issue Discount. The taxable income of MTNV/MSI for years ended 1984 through 1991 totaled $9,024,857. The total royalty/franchise payment paid to Manver for that period was $7,031,787. Of the preroyalty payment profits, 56 percent went to MTNV/MS and 44 percent went to Manver as royalty and franchise payments. In August and September 1985, J. Russell Hamlin (Hamlin) of C&L Orlando sent two letters to Lesley Gelabert (L. Gelabert), A. Gelabert’s wife, at Inverspan, regarding Inverspan, MTNV, and - 77 Eurotor. The letters informed L. Gelabert that the Internal Revenue Service (IRS) had issued new reporting requirements for U.S. corporations and foreign corporations operating in the United States that are owned by a foreign person. The requirement was that a reporting entity had to report each transaction with a “related party” on IRS Form 5472, Information Return of a Foreign Owned Corporation. One letter stated that transactions were defined broadly and included commissions, interest, rents and royalties paid and received, loans, sales, purchases, and services performed by or for the reporting entity. The letter continued: Separately, it is expected that the IRS will utilize the information contained on Form 5472 to determine whether the reported transactions were conducted at “arms-length”. Thus, in reviewing transactions for preparation of the Form 5472, the vulnerability to attack by the IRS under the Section 482 arms-length standard should also be considered. Hamlin sent a final IRS proof copy of Form 5472 with instructions. Hamlin also offered to assist L. Gelabert in reviewing transactions to determine whether they must be reported and “to further assist in minimizing the exposure to future IRS audit adjustments under Section 482.” No Forms 5472 were filed with the MTNV 1987 Federal return. Neither MTNV nor MSI filed Forms 5472 with their Federal returns for fiscal years ended 1988 and 1989 for transactions engaged in with Manver, Gatetown, Lince, Futureprom, Attractours, Edemle, Celin, Amsrott, Slider, Protravol, Etano, N.V. (Etano), or - 78 Lebasi, N.V. (Lebasi). Linda Parks (Parks) of C&L Orlando prepared and signed the MSI 1988 return. Sans. It was also signed by At the time she prepared the return, Parks was aware of the Form 5472 requirement but did not know that the franchise fee was being paid to a related party. B. MANV/MDT The MANV/MDT Federal tax returns for fiscal years ended November 30, 1987 through 1990, were prepared by the Los Angeles C&L office. Statements attached to the returns indicated that MANV transferred its assets to MABV and that MABV transferred its assets to MDT, in section 351 transactions for stock and securities. The statements included information that MABV had assumed all of the liabilities of MANV. MANV/MDT reported the following on its Federal tax returns: FYE Nov. 30 Gross Receipts Total Income Taxable Income Royalties/ Franchise Payments 1987 1988 1989 1990 $14,409,710 18,665,675 21,278,643 31,251,794 $10,601,670 13,836,206 15,537,012 22,688,216 $4,347,581 1,183,497 1,054 389 5,563,637 $1,441,924 3,719,321 5,148,541 2,975,726 1,730,776 24,047,269 442,963 2,817,007 248,004 4,396,287 12/31 Calendar Year: 1990 1991 2,367,034 34,793,808 Additionally, petitioners MANV/MDT claimed deductions for payments it made as management and consulting fees in the amounts of: - 79 MANV/MDT Eurotor RC A. Gelabert Santandreu Segui 1987 1988 1989 $271,041 132,937 16,580 37,000 44,000 $373,854 380,096 17,215 21,069 $ 37,546 228,128 21,877 8,000 Included in the 1987 through 1990 returns were additional deductions for royalties/franchise fees and interest expenses. The 1988 and 1990 returns also claimed deductions for guarantee fees. For fiscal years ended 1986 through 1991, MANV/MDT’s taxable income totaled $15,738,227. During the same period, payments to Manver for franchise/royalties fees totaled $18,336,335. Of the preroyalty payment profits, 46 percent went to MANV/MDT and 54 percent went to Manver. No Forms 5472 were filed by MANV/MDT on its 1986 through 1991 income tax returns for transactions with Manver, Gatetown, Lince, Futureprom, Attractours, Edemle, Celin, Amsrott, Slider, Protravol, Etano, or Lebasi. Forsyth reviewed and signed the Federal returns for 1986 through 1989. Forsyth believed that Manver and MDT were related, but Onate informed him in August 1987 that Manver and MDT were not related. On August 11, 1989, Forsyth signed the MDT Federal income tax return for the fiscal year ended November 30, 1988, which was filed without Forms 5472. August 11, 1989, was less than 2 weeks after the November 30, 1988, MDT certified audit report was issued that disclosed that Manver was a related party. - 80 C. Eurotor Eurotor's Federal income tax returns for the fiscal years ended July 31, 1986, and July 31, 1987, reported income effectively connected with a trade or business in the United States. Eurotor's Federal income tax return for the fiscal year ended July 31, 1988, was marked "Final Return" and contained the following statement: Eurator S.A. (98-0063013) is not effectively connected with the conduct of a trade or business accordingly, Eurator S.A. is not required to file a U.S. income tax return of a foreign corporation (Form 1120F). The return did not report any effectively connected income for 1988. XIV. Certified Audit Forsyth and Kim were involved in the C&L audits of the Florida entities. They provided information to C&L in Florida. Kim sent to C&L in Florida a related-party list in which he indicated that Eurotor, Futureprom, Gatetown, Lince, Primavert, RC, Estaspan, and Manver were not related parties. Kim also crossed off the Spanish investors’ names as owners of their respective Netherlands Antilles corporations. A C&L employee prepared a workpaper entitled “Related Parties”. The initial determination of related parties included Manver, Gatetown, Futureprom, and Lince. The employee noted that, after subsequent discussions with the client, it was determined that Manver, Gatetown, Futureprom, and Lince were not related. C&L was advised in the MDT audit for the fiscal year - 81 ended November 30, 1988, that the commercial paper debt was owed to unrelated parties. The reports for the audits of MSI for the fiscal years ended July 31, 1989 through 1993, did not reflect that Manver, Gatetown, or the commercial paper companies were related to, or an affiliate of, MSI. XV. IRS Audit Internal Revenue Agent Gary F. Herold (Herold) worked on the Medieval Times examinations from September 1988 until the summer of 1991. Herold worked with Sans, Parks, Kim, and Melody Blunk on the examinations. Kim had left C&L and was then employed by the Medieval Times companies. IRS international examiner Michael Bruton (Bruton) used information provided to him by the Medieval Times representatives to prepare date schedules and organizational charts. During the examination, Bruton was not given a signed contract between TM and Gatetown dated March 1, 1986, for consideration of $7,312. Santandreu informed Bruton and Herold that Gatetown and Manver were owned by de Oteyza (45 percent), Mayol (45 percent), and Santandreu (10 percent). Santandreu provided a document to the IRS that stated that he did not know the shareholders of several corporations, including Dapy, Promidux, Lince, and Manver, because “these are private companies who are doing services for us.” Between 1982 and 1991, A. Gelabert, Santandreu, and Segui held positions as officers, directors, attorneys in fact, powers of attorney, or trustees in the listed companies as follows: - 82 A. Gelabert--Attractours, Calinvest, Dapy, Holiday, Inverspan, Lince, MTNV, Primavert, Promidux, Roundabout, RC, Spectrust, and Wayout; Santandreu--Amsrott, Attractours, Calinvest, Celin, Etano, Futureprom, Gatetown, Inverspan, Lebosi, Lince, MICV, Manver, MABV, MANV, MTBV, MTNV, Primavert, Protravol, Roundabout, and Slider; Segui--Calinvest, Futureprom, Holiday, Inverspan, Lince, Manver, MTNV, Primavert, and TM. Formal document requests were made to Kim for the MTNV stock and minute books and Manver’s tax returns. Bruton received these documents. Neither Herold nor In an October 8, 1990, letter to Bruton, Forsyth stated: You should also note that to the best of our knowledge, Manver N.V. has only one minority shareholder in common with Medieval Times N.V. Therefore, Medieval Times, N.V. is not in a position to compel Manver N.V. to produce the requested tax returns. * * * On June 2, 1992, Greg Cox, an international examiner with the IRS, sent to MDT a notice stating that MDT had been assessed a penalty for not filing certain Forms 5472 as required by section 6038A(b). The notice also stated that further penalties would be assessed if the forms were not submitted for transactions between MDT and MABV, Calinvest, RC, Eurotor, Manver, and Gatetown. Kim submitted the forms on behalf of MDT. S [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A2f1c1c7b303430ff. Public record. Not legal advice.