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8
T.C. Memo. 1996-455
UNITED STATES TAX COURT
MEDIEVAL ATTRACTIONS N.V.,¹ Petitioners y.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 20532-91,
20534-91,
20537-91,
15975-92,
.45_8_7 - 9-3-,.
20533-91,
20535-91,
20538-91,
16122-92,
8 92 3 - 9 3 .
Filed October 9, 1996.
Lawrence L. Hoenig, Stephen J. Martin, Lisa F. Cetlin,
A. Keller Young, and David I. Bass, for petitioners.
¹Cases 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.
BEa
DCT
3
- 2 -
Howard P. Levine, Beniamin A. deLuna, Kim A. Palmerino, and
Robert F. Conte, for respondent.
Table of Contents
FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . .
I.
II.
8
Background . . . . . . . . . . . . . . . . . . . . . .
9
Expansion to the United States .
.
10
. . . . . . . . . . . . . .
10
.
.
.
A.
Florida--Personnel and Pre-1986
B.
California--Personnel and Pre-1986
Corporate Structure
.
.
.
.
.
.
.
Corporate Structure . . . . . . . . . . . . . .
Continued Development . . . . . . . . . . . . . . . .
Contracts . . . . . . . . . . . . . . . . . . . . . .
20
24
26
V.
Coopers & Lybrand Planning and
Petitioners' Documentation . . . . . . . . . . . . .
27
VI.
Trademarks and Copyrights
50
VII.
Section 351 Transfers
VIII.
California and New Jersey Expansion
III.
IV.
. . .
.
. . .
.
. . .
.
. . . . . . . . . . . . . . . . I 52
. . . . . . . . .
56
X.
XI.
Marketing Agreement . . . · · · . . . . . . . . . . .
Commercial Paper . . . . . . . . . . . . . . . . . . .
63
64
XII.
Royalty Transactions Relied Upon in
A. California . . . . . . . . . . . . . . . . . . . .
B. New Jersey . . . . . . . . . . . . . . . . . . . .
C. C&L Advice . . . . . . . . . . . . . . . . . . . .
IX. Dividends . . . . . . . . . . . . . . . . . . . . . .
XIII.
XIV.
XV.
Federal Tax Returns
. . . . . . . . . . . . . . .
56
57
58
61
71
Federal Tax Returns . . . . . . . . . . . . . . . . .
B. MANV/MDT . . . . . . . . . . . . . . . . . . . . .
C. Eurotor . . . . . . . , , . . . . . . . . . . . .
71
74
76
Certified Audit . . . . . . . . . . . . . . . . . . .
IRS Audit . . . . . . . .
76
A. MTNV/MSI . . . . . . . . . . . . .
- 3 -
OPINION
I.
. . . . . . . . . . . . . . . . . . . . . . . . . . 79
Management and Consulting Fees . . . .
. .
. . . . .
.
.79
Compensation in Proportion to Stockholdings
.
83
A.
Eurotor . . . . . . . . . . . . . . . . . . . . .
1. Services . . . . . . . . . . . . . . . . . . .
B.
Royal Catering . . . . . . . . . . . . . . . . . .
C.
2.
82
82
88
A. Gelabert, Santandreu, and Segui .
.
.
.
.
.
.
.
II.
Franchise Transactions and Royalty Fees
.
. .
.
.
.
., 91
III.
Interest Expense and Guarantee Fees Resulting
From Lump-Sum Franchise Payments . . . . . .
.
.
.
. 107
IV.
Interest Deductions on the
V.
The $236,313 That MDT Paid to
VI.
New Jersey and California Expansion Expenses . .
VII.
Additions to Tax and Penalties for
Section 351 Transactions . . . . . . . . . . . . . . 117
MSI as a Marketing Fee . . . . . . . . . . . . . . . 123
A.
B.
VIII.
89
.
.
. 124
Fraud and Negligence . . . . . . . . . . . . . . . . 126
Fraud . . . . . . . . . . ... . . . . . . . . . . 126
Negligence . . . . . . . . . . . . . . . . . . . . 131
Substantial Understatement and Increased Interest
A. Substantial Understatement . . . . . . . . . .
B. Increased Interest . . . . . . . . . . . . . .
.
.
.
. 136
. 136
. 137
IX.
Withholding of Tax at the Source . . . . . . . . . . . 138
A. Interest That MDT and MSI
Paid to MABV and MTBV, Respectively . . . . . . 140
B. Franchise Fees That Were Paid by MANV to Manver in
Fiscal Year Ended November 30, 1987
. . . . . . 141
C. MDT and MSI Payments to Manver in March 1988 . . . 142
D. Amounts That MANV, MSI, and MDT Paid to Eurotor as
Management and Consulting Fees . . . . . . . . . 143
E. Guarantee Fees Paid to Dapy and
Roundabout in Connection With the
Commercial Paper Transactions
. . . . . . . . . 144
X.
Failure To Deposit Withholding Tax .
.
.
.
.
.
.
.
.
. 145
I
- 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 .
Etano
.
. . . . . . . . . Estaspan, Ltd.
. . . . . . . . . . . . Etano, N.V.
Eurotor
. . . . . . . . . . . Europea de Espe¢taculos,
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
KDS
.
.
. . . . . . . . . . Inverspan, N.V.
.
.. .
.
.
.
.
.
.
.
. Kingdom of Dancing Stallions
LL . . . . . . . . . . . . . . Lyon & Lyon
Lebasi . . . . . . . . . . . . Lebasi, N.V.
Lince . . . . . . . . . . . . Lince, N.V.
MANV . . . . . . . . . . . . . Medieval Attractions, N.V.
MCI . . . . . . . . . . . . . Meadowland Castle Inc.
MDT . . . . . . . . . . . . . Medieval Dinner
Tournament, Igc.
MICV . . . . . . . . . . . . . Manver Internatiqnal, C.V.
MSI . . . . . . . . . . . . . Medieval Show, Inc.
MTBV . . . . . . . . . . . . . Medieval Times, B.V.
MTNV . . . . . . . . . . . . . Medieval Times, N.V.
Manver . . . . . . . . . . . . Manver, N.V.
MABV . . . . . . . . . . . . . Medieval Attractions, B.V.
NCB . . .
Primavert
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
. National Community Bank
. Primavert, N.V.
Protravol
RC . . . .
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
. Protravol Limited
. Royal Catering, Inc.
Promidux . . . . . . . . . . . Promidux, N.V.
Roundabout . . . . . . . . . . Roundabout Tours, N.V.
SDCI .
.
.
.
.
.
.
.
.
.
.
.
. San Diego Castle, Inc.
Wayout .
.
.
.
.
.
.
.
.
.
.
. Wayout Tours, N.V.
Slider . . . . . . . . . . . . Slider, N.V.
Spectrust . . . . . . . ... . Spectrust, N.V.
TM . . . . . . . . . . . . . . Torneo Medieval, $.A.
- 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
Additions to Tax
Year
Sec.
Sec.
Sec.
Ended
Deficiency
6653(a)(1)(A)
6653(a)(1) (B)
6661
11/30/87
$929,752
$46,488
50% of
interest due
on $929,752
$185,950
Docket No. 20534-91
Tax
.
Year
Ended
11/30/87
Additions to Tax
Deficiency
Sec.
6653(a)(1)(A)
$929,752
$46,488
Sec.
6653(a)(1) (B)
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
Additions to Tat
TæK
Year
Ended
Deficiency
7/31/88
$808,755
Sec.
Sec.
$ec.
Sec.
6653 (b) (1) (A)
6653 (b) (1) (B)
653 (b) (1)
6661
$606,566
50% of
interest due
--
$202, 89
$652,261
217,420
on $801B,755
7/31/89
869,682
Docket No. 16122-92
Year
Deficiency
Addiition 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
Additions to Tax and Penalty
Year
Ended
Deficiency
Sec.
6653(a)(1)
Sec.
6661
Séc.
6662(a)
-
11/30/88
11/30/89
$2,526,905
2,929,741
$126,345
--
$631,726
--
-$$85,948
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
franchise transactions petitioners entered into were bona fide
o
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.
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
- 8 -
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 b
parties.
the
Many of them aré exaggerated extrapolations or
unrealistic interpretations of the évidence.
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.
Th
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 o
business in Kissimmee, Florida.
Tournament, Inc.
Petitioner Medieval Dinner &
(MDT) , is a corporation organized under the läws
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
_ 9 _
of The Netherlands, and MABV is a successor in interest to
Medieval Attraction, N.V.
(BUunT), a corporation organized under
the laws of the Netherlands Antilles.
I.
Badkground
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
-
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.
- 10 -
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. Mont'aner' s show and wanted to bring it to Benidorm.
Clim nt
contacted J. Montaner, and they agreed to open a show in
Benidorm.
On January 25, 1977, Torneo Medieval, S.A.
incorporated in Spain.
(TM) , was
The initial shareholders of TM were
Climent, 45 percent; J. Montaner, 13 percent; Juan Colom
Valcaneras, 15 percent; Juan-Pedro Rousselet Barbaud (Roussel t) ,
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 henidorm show
as
similar to the Son Termens show, and, over time, innovations
ere
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.
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 nightcl b
operated on Mallorca that catered to tourists.
He also owned a 1
interest in La Granja, a medieval village on Mallorca.
Alfonso
- 11 -
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:
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
- 12 -
company; 20- to 50-percent owner in several other businesses,
including nudist camps and nightclubs; owner c¼f land and
property; personal estate value of $4.1 million.
Sequi:
41 years old; bachelor's degree; ,100-percent owËer
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 ow er
of dinner show, hotel, jousting show; personal estate value of
$1 million.
In 1980, Segui and J. Montaner traveled to the United St tes
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
Kissimmee, Florida.
A sales contracti 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
- 13 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
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.)
- 14 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 cast e.
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 fr m 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 cÖntained 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 o en
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 State
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
- 15 -
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.
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
- 16 -
(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 M'I'NV shareholder
consisted of the Netherlands Antilles corporations:
Spectrus ;
Promidux; Dapy; Roundabout; Attractours; Wayout; Holiday; and, in
his individual capacity, Chavez.
Chavez, a U.S. citizen, was
ot
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 castl .
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; recruitihg
and training 70 to 100 persons to be employed by MTNV,
particularly kitchen staff; ensuring all aspects of the
- 17 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.
Allen on June 30, 1983.
corporate director.
(RC), was incorporated in Florida by
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
A. Gelabert and Jose "Pepe" Sans (Sans).
loaned $100,000 to RC.
The MTNV shareholders
The loan was repaid between March and
June 1985.
The interest on the loans was paid from an MTNV
account.
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.
- 18 By the end of 1982, Chavez was no longer involved in t e
daily Florida operation that was run primarily by A. Gelabert and
Castro.
A. Gelabert was in charge of the castle constructio ,
aspects of the show, and the food and beverages.
A. Gelaber
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 nu
ers
and liquor licenses, procured services, paid bills, purchase
restaurant equipment, provided for the care of the horses, and
coordinated the kitchen design and construction.
Stonecrow was knowledgeable about the medieval era and
maintained the historical authenticity of the show.
designed and sewed costumes and painted murals.
Stonecrok
Stonecrow wa
the producer of the ·MTNV show in Florida and was the master o
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
- 19 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
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.
A. Gelabert also asked Galindo to
set up a photography department.
Galindo researched equipment
and presented the information to A. Gelabert.
A. Gelabert chose
- 20 -
a photography equipment company that provided a 2-week train ng
session with the purchase of equipment.
To the best of Gali do's
knowledge, no one at MTNV knew anything about photography
equipmeint .
Galindo set up the lab and hired and managed the six
employees who worked in the photography departinent.
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 ind
the type of shots available to the customers, however, were n w.
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 successf 1
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, Santandrëu, 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
lh85, Bellows
and Kudlacz went to Southern California and met wit
Wesley
Taylor (Taylor) , a commercial real estate broker.
aylor had a
listing on property that had formerly belonged to a company
- 21 -
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.
Iditially, 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
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.
and MANV were as follows:
The shareholders of Calinvest
- 22 -
Interest
in MANV
Interest
in Calinvest
Dapy (Kahne¹)
Holiday (Segui¹)
Primavert (Santandreu2)
Promidux (P. Montaner¹)
Roundabout (Santandreu¹)
12%
12%
12%
12%
12%
17%
17%
20%
17%
17%
Spectrust (Valiente2)
5%
5%
Wayout (Climent2)
.
Royal Catering (A. Gelabert1)
Estaspan, Ltd.
5%
5
5%
5%
2%
-
Santandreu
5%
J. Montaner
Segui
Kahne
5%
5%
5%
Name
-
¹Denotes the owners of the corporations who held the interest
MANV and Calinvest.
Estaspan, Ltd.
(Estaspan) , was a Bermuda corporation
controlled by Gavin H. Watson, Jr.
banker in Florida.
operation.
in
(Watson) .
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.
hired a general contractor and a kitchen contractor and brought
A. Gelabert also brought several artists from Florida and hired
e
- 23 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
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.
- 24 -
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 ex i.sting buildin(; 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
5$0,000
575,000
600,000
The California ·castle opened in June 1986.
From 1986 to
1989, many renovations and additions were made to the Californ a
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 presiden
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
for "salary, payroll taxes, insurance and other related expense
- 25 -
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.
Bóth 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.
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
- 26 (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
composing an original score.
f
Schwartz and Friedman prepared a
demonstration recording for A. Gelabert.
A. Gelabert liked
he
demonstration, so Schwartz and Friedman composed music for the
entire show.
Schwartz and Friedman produced the music at th ir
own risk and presented it to the Spanish investors.
The Spa ish
investors approved the score and paid Schwartz and Friedman
$18, 000 for their finished product.
The fee was originally
aid
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 Éxcalibur Hotel and
Casino in Las Vegas,· Nevada.
Hartzell was interested in loca ing
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
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 shareholder
wanted assurances that they would be compensated for their
- 27 -
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.
agreements.
His notes did not contain a reference to any other
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.
- 28 -
In 1985, Santandreu sought the assistance of C&L in
Brussels, Belgium, to find a structure that could be used fo
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
042acquire
Gatetown,
he
letter stated that "Gatetown Limited will take care of getting
paid Royalties and copyrights of a Dinner-Show situated in th
U.S.A."
The correspondence also referred to a company called
Protravol Limited (Protravol) that would be used for the "buyi g
and selling from Spain to U.S.A. of souvenirs".
The letter
informed Harris that the directors of both companies should be de
Oteyza and Jaime Antonio Mayol Castaner (Mayol) , Segui' s broth r-
in-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 Mallor
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 Oteyz
were named as the officers.
The Gatetown stock, which consiste
,
- 29 -
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,
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.
- 30 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:
trademark attorney.
None registered.
Notes dated May 20,
"Royalties.
Which company should o
trademark - where? Copyright - Which Co.?
3 Spanish nationals
'own'.
(Florida Co. Not now paying royalties)".
state:
"Trademark - offshore.
tax [profit] .
Problem:
Recom end
Objective:
The notes also
10% [royalty] of pre-
Ownership of intangibles."
Additionally, the notes reflect that the Spanish operation
trained the Florida personnel and provided techhical and
logistical support but that the structure was set by the Florida
operation, which sent people to California.
agreement, the notes state:
Regarding a licerse
"License agreement from foreign
corp. to NV-Florida for UK Co.?"
Forsyth wanted to determine a method to make payments to
he
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 corpor te
- 31 -
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.
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
- 32 -
for interest paid to Dutch companies, and dividend income fram
the U.S. company would be tax-exempt in The Netherlands.
A section in the September draft letter discussed royalRy
payment's on intangible assets.
The letter stated:
understand that it is intended to license M.T.U.S.
"We
[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.
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 tak 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
- 33 -
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 aof December 31, 1986,
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
- 34 -
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 KingCom.
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
"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, i
was still uncertain who would "own" the intangibles that were
being licensed.
Hokanson spoke with Forsyth on hTovember 7, 19 6,
regarding the licensing agreement.
In a letter to Forsyth dated
November 11, 1986, Hokanson enclosed a new draft of the licens ng
agreement.
The new draft expanded the scope of services provi ed
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 fel
- 35 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. Geldbert.
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.
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
- 36 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
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
- 37 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
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.
- 38 -
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
royalti'es from two NV companies that were operating amusement
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 Mediev 1
Times for the first time.
The documents represented, among o her
things, that the Medieval Times organization was a franchise.
Onate sent copies of six documents to Forsyth, ;only one of wh:.ch
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 arrangeme t
as in the January 24, 1983, contract that Allen drafted,
- 39 -
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
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
- 40 EUROTOR and TORNEOS [TM3 , it is put in evidende that TORNEOS [TM)
is the exclusive owner of this FORMULA, that in other countries
is named Franchising. "
The document listed Santandreu as th
represèntative 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
nly
signed document.
The third document was dated February 1, i983, and title
"CONTRACT BETWEEN TORNEO MEDIEVALES S.A. AND MEDIEVAL TIMES
.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
period of 5 years beginning February 1, 1983, "that the latter
may use the name of MEDIEVAL TIMES, trademark, idea, guide an
operations manual, which are the property of TORNEOS [TM] in
he
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 cliehts
per day, as set forth in the January 20, 1983, joint
venture agreement between TM and Eurotor.
TM wais to assist MTUV
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
- 41 -
preparing and serving meals).
quality control.
TM was also to be responsible for
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.
- 42 As of January 1, 1988, Manver was to pay to TM 1, 000, 00
pesetas.
TM was to "deliver, authentically, the name, tradethark
and hand-book of the FORMULA to MANVER, in the act of signinc
this ccintract."
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 managemen
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 Janua y 20, 1983,
agreement) was terminated.
The document referred to the
January 24, 1983, management agreement between Isurotor 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.
The management agreement between Eurotor and MANV was dated
February 1, 1986, and named as representatives A. Gelabert for
- 43 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.
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.
- 44 -
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 documertt
between' MTNV and TM dated February 1, 1983.
One letter,
addressed to Sans, was in Spanish and informed MTNV that Man er
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 represen
a
sale from Gatetown to Manver of all the rights .to the "patent
trademark, copy right, trade secret, contracts, * * * includi g
the goodwill, services, production, advertising., distribution,
marks, ideas, concept, operations manuals, show scripts, and the
name MEDIEVAL TIMES, which are identified by the marks 'MEDIE AL
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 off $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, 1907.
The document was signed by Mayol for Gatetown and by Nouel (an
attorney at CANV) for Manver.
An annex to the Bill of Sale between Gatetown and Manver
provided that the annual installments of $760,000 b.eginning
June 1, 1987, should have added to them simple interest of
9 percent per year payable monthly on the outstanding balance.
- 45 -
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, 2-1/2 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
(10u07 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
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
- 46 -
suggested by Forsyth in the November 1986 draft letter. The draft
letter was prepared several months after the date placed on
licensing agreements.
he
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 beg;i.nning
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
as
substantially identical to the language in the draft of a
licensing agreement prepared by Hokanson and foiwarded to Forsyth
on November 11, 1986, which was several months after the date
the licensing agreements.
f
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 198 .
Futureprom, N.V.
(Futureprom) , was a Netherlands Antilles enti y
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
- 47 -
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
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, i986, and was signed by Mayol
for Gatetown and by Nouel of CANV for Futureprom.
1
- 48 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 Gatet own and by Secjui
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 a d
Futureprom, Gatetown was now agreeing to pay to Lince 95 perc .nt
of all of the income received from Medieval Attractions, N.V.
(Buena Park, U.S.A.) , and to pay to Futureprom 95 percent of Lll
of the income received from Medieval Times, N.V.
U.S.A.) .
(Kissimmee,
The document was signed by Segui for Lince and by Nouel
for Futureprom.
It was dated June 1, 1986.
Gatetown' s existence was reflected in other documents
maintained by Harris, including a copy of the Spanish version cf
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 "Gateto n
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.
- 49 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:
1988
Futureprom N.V.
Lince N.V.
$
Manver International, C.V.
786,085
1,172,763
1989
$1,678,138
3,735,209
(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
- 50 -
property and franchising rights etc., hereinafter
referred to as "The Intellectual Property" * * *
In consideration of the sale, MICV agreed to pay to Man, er
$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 Timas.
The name Medieval Times had not been used previously in the
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.
Fron
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.
Invoice3
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,
- 51 -
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
.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.
- 52 -
VII.
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 $5,58 ,577
for MANV and $3,670,936 for MTNV.
The valuatijon reports stat ed:
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.
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 r¾levant 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 ;he
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 dsed 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,
- 53 -
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
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
- 54 -
on October 6, 1988.
The Inspector of Taxes agreed, among otlker
things, that interest would not be imputed on the specified
on-
interest-bearing loans.
Solne 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 wete 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 td its liabilities,
to MTBV for a total consideration of $4.4 million (U.S.) .
Of
this amount, 1.723 million Dutch Guilders was paid in stock o
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-beating $2.64 mil
on
loan was "payable in ten years on presentation of this promiss ry
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 interest
bearing promissory note.
The terms of the promissory notes
- 55 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.
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 1,0 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.
- 56 -
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, 198'7, and December 1,
1987, respectively.
MSI and MDT signed new management contracts
with Eurotor dated August 1, 1987, and December 1, 1987,
respectively.
VIII.
California and New Jersey Expansion
A.
California
The Medieval Times group began to expand its operations.
December 15, 1987, Glendale Castle, Inc.
in California.
On
(GCI) , was incorpora ;ed
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 zóning to
accommodate the new castle facility and on an acjreement 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 fe es
to RC.
MDT deducted these expenses on its Federal tax returns in
- 57 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
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.
Watson went to
- 58 -
New Jersey to assist with the development.
He opened bank
accounts at National Community Bank (NCB) in New Jersey in MOI's
name; made a presentation to the City Council of Lyndhurst,
ew
Jersey;' and negotiated with a landlord for a lease in the na e of
MCI.
On July 20, 1988, A. Gelabert directed the Australia arid
New Zealand Bank (ANZ Bank) to transfer $45,000 from the "Wa out
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.
It1 December 198E,,
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 castla
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.
stated:
The letter further
- 59 -
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.
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
- 60 -
therefore be currently deductible as long as they are not capital
expenditures.
With regard to the deduction for the amortization expense,
C&L noted that, for the deduction to be taken, the transfere
a franchise must also be conducting a trade or business.
of
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 wàs an issue as
o
whether or not a trade or business existed with respect to MC
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] änd
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]
- 61 -
until after the operation commences at each location.
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 ·
$ 31,070.42
45,676.99
45,674.67
Roundabout
29,413.55
Holiday
Wayout
29,413.55
25,892.41
Alfonso Chavez
Gloria Chavez
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:
- 62 -
Spectrust
Promidux
Dapy
Attractours
Roundabout
Holiday
Wayout
Gerard 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
Alfonso Chavez
28,085.13
Gloria Chavez
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 Sansh, in
a letter dated June 17, 1987, to pay additional dividends.
The
dividends were paid in June 1987 as follows:
Spectrust
$ 66,665.00
Promidux
P. Montaner
Dapy
Kahne
Roundabout
Roundabout
52,502.50
12,250.00
52,502.50
12,250.00
50,610.00
1,055.55
Santandreu
12,250.00
Holiday
50,610.00
Holiday
Segui
1,055.55
12,250.00
55,555.00
66,000.00
9,800.88
22,321.51
22,321.51
$500,000.00
Wayout
Attractours
Gerard Chavez
Alfonso Chavez
Gloria Chavez
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.
MANV paid dividends once, during the fiscal year ended
November 30, 1987.
The dividends totaled $2.5 million.
No
- 63 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
fiscal year.
The agreement stated that the payment was to be
paid in return for services that MTNV provided to MANV regarding
the:
- 64 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 tlae economical
conditions marketed by M.A.
The payment was to be due "not later than one year after the
filing by M.A.
[bCOR7] 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 w1ich
Onate enclosed a copy of the marketing agreement for her filea.
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 exist d
between the United States and the Netherlands Antilles.
The
termination would have had an effective date of January 1, 19E8.
Because the termination would have affected the Medieval Time
companies, C&L advised them to consider accelerating any payments
that were scheduled to be made to the Netherlands Antilles
- 65 -
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
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.
The MDT discounted present value amounts were
- 66 -
computed "as:
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 wou'ld have collectively given Manver promissory notes for
$22.5 million in 1987 and paid interest on the promissory notles
monthly.
The principal would have been due in 5 years.
Under the lump-sum plan, MSI and MDT would have been sub'ect
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 ta
on
interest on promissory notes (commercial paper) with a term o
less than 183 days.
Forsyth dealt primarily with Santandreu and Onate concerr ing
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 thanager 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 .
to provide additional funds.
Either way, the tender panel
manager had to have the cash prior to the maturity of the firs
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
- 67 -
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.
Fdrsyth 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
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.
- 68 -
On December 29 and 30, 1987, Gatetown transferred $7,13 ,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 t ree
negotiàble 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 pa er
was issued, and $12.5 million in promissory not;es.
Amendments were drawn up to the MDT/Manver and MSI/Manver
licensing agreements to reflect the new lump-sum payment term .
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:
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,
- 69 -
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
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.
Celin, N.V.
(Celin); and Slider, N.V.
(Amsrott);
(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 $1:0 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
- 70 -
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 tot ling
$10.5 million.
At the same time, another tranche of commerc al
paper totaling $10 million was issued.
As each tranche of funds matured, a new set of transacti ns
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 i
MTNV and MANV.
Dapy and Roundabout acted as guarantors on the commercial
paper transactions and received fees for the service.
Althoug
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 dades
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
- 71 -
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,
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
- 72 -
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 securit es
issued, and liabilities assumed:
"Medieval Times B.V. has
assumed all of the liabilities of Medieval Times, N.V."
MTNV/MSI reported the following on its Federal tax returns :
Taxable
Income
Royalt es/
Francha.se
Payment s
636,'795
1, 308, 856
1, 485, 473
$
FYE
July
Gross
Receipts
Total
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, 00
$
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.
- 73 -
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
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
- 74 -
and "to further assist in minimizing the exposure to future ::RS
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 ret rns
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.
Lebasi, N.V.
(Lebasi).
Linda Parks (Parks) of C&L Orlando
prepared and signed the MSI 1988 return.
Sans.
(Etano), or
It was also signed by
At the time she prepared the return, Parks was aware cf
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 tha
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 ha
assumed all of the liabilities of MANV.
MANV/MDT reported the following on its Fed ral tax returns:
- 75 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:
MANV/MDT
Eurotor
RC
A. Gelabert
Santandreu
Segui
1987
1988
1989
$271,041
132,937
16,580
37,000
$373,854
380,096
17,215
21,069
$ 37,546
228,128
21,877
8,000
44,000
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,
- 76 -
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 th'at Manver and MDT were not related.
On August 11, 19d9,
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.
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 ykar
ended July 31, 1988, was marked "Final Return" and contained 1.he
following statement:
Eurator S.A. (98-0063013) is not effectively connected
with the conduct of a trade or business ac,cordingly,
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
- 77 -
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
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).
- 78 -
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 Segdi
held positions as officers, directors, attorneys in fact, po ers
of attorney, or trustees in the listed companies as follows:
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, Roundabput,
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 not
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 assess d
a penalty for not filing certain Forms 5472 as required by
section 6038A(b) . ' The notice also stated that further penalti s
would be assessed if the forms were not submitted for
- 79 -
transactions between MDT and MABV, Calinvest, RC, Eurotor,
Manver, and Gatetown.
Kim submitted the forms on behalf of MDT.
Some of the forms had disclaimers attached that stated:
It is our opinion that Medieval Dinner &
Tournament, Inc. and * * * do not meet any of the
definitions defining the boxes in Part II, 3. By
filing the attached Form 5472, Information Return of a
Foreign Owned Corporation, pursuant to Section 6038A,
Medieval Dinner & Tournament, Inc. is not admitting
that * * * was a "related party" of Medieval Dinner &
Tournament, Inc. during the period * * * under Sections
6038, 6038A or any applicable Section, law or code; and
Medieval Dinner & Tournament, Inc. is not admitting
that there exist any "reportable transactions" between
Medieval Dinner & Tournament, Inc. and * * * for the
period * * * under Sections 6038, 6038A or any
applicable Section, law or code.
There were disclaimers for transactions with RC, Eurotor, Manver,
and Gatetown.
OPINION
With the exception of the additions to tax and penalties for
fraud, petitioners have the burden of proving that respondent's
determinations as made in the notice of deficiency are erroneous.
Rule 142(a); INDOPCO,
Inc. v. Commissioner, 503 U.S. 79,
84
(1992); Rockwell v. Commissioner, 512 F.2d 882, 886 (9th Cir.
1975), affg. T.C. Memo. 1972-133.
I.
Management and Consulting Fees
Petitioners MANV/MDT and MSI claimed deductions for payments
made for management and consulting fees in the following amounts:
- 80 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
1988
1989
$232,549
$86,341
MSI
Eurotor
With the exception of a portion of MANV/MDT's 1987, 1988, and
1989 payments t.o Eurotor, respondent determined that the above
amounts are not deductible under section 162(a) because the
payments represented a distribution of profits.
Section 162(a) allows deductions for all "ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business".
Management expenses are
among the items included in business expenses.
Income Tax Regs.
Sec. 1.162-1,
The test of deductibility of payments made for
services, whether compensation or management, is whether the
payments are reasonable and are in fact payments purely for
services.
Achiro v. Commissioner, 77 T.C. 881, 903 (1981); sec.
1.162-7(a), Income Tax Regs.
A bona fide contract for management
services may be a factor in establishing deductibility.
v. Commissioner, supra.
Achiro
Whether an expense that is claimed
pursuant to section 162(a) is compensation for services rather
than a distribution of profits is a question of fact that must be
decided on the basis of the particular facts and circumstances
Paula Constr. Co. v. Commissioner, 58 T.C. 1055, 1058-1059
(1972), affd. without published opinion 474 F.2d 1345 (5th Cir.
- 81 -
1973).
If the corporation is closely held and the persons
receiving the payments are shareholders, the payments are subject
to close scrutiny to determine whether the alleged compensation
is in fact a distribution of profits.
Commissioner, 716 F.2d 1241, 1243
Elliots, Inc. v.
(9th Cir. 1983), revg. and
remanding on other grounds T.C. Memo. 1980-282.
Management fees
paid to related parties in excess of reasonable arm's-length fees
are not deductible.
T.C. 199, 218
100
Latham Park Manor, Inc. v. Commissioner, 69
(1977), affd. without published opinion 618 F.2d
(4th Cir. 1980).
The cases contain a lengthy list of factors that are
relevant in the determination of reasonableness of compensation,
including:
The employee's qualifications; the nature, extent,
and scope of the employee's work; the size and complexities of
the business; a comparison of salaries paid with gross income and
net income; the prevailing general economic conditions; a
comparison of salaries with distributions to stockholders; the
prevailing rates of compensation for comparable positions in
comparable concerns; the salary policy of the taxpayer as to all
employees; and the amount of compensation paid to the particular
employee in previous years.
Mayson Manufacturing Co. v.
Commissioner, 178 F.2d 115, 119 (6th Cir. 1949), revg. a
Memorandum Opinion of this Court dated Nov. 16, 1948.
Petitioners applied to the facts in the instant cases the
factors listed in Mayson Manufacturing Co. and conclude in their
brief that "it is clear that the management and consulting fees
- 82 -
at issue were ordinary, necessary, reasonable and consistent with
an arm's-length charge." . The facts on which petitioners base
their conclusion include Eurotor's oversight of the Medieval
Times o'perations, RC's catering and ranch operations, and Seghi's
and Santandreu's positions as members of various boards of
directors and their assistance with the New Jersey and Califo nia
expansions.
Respondent's primary arguments to support her determinat on
that the fees paid as management and consulting fees were
disguised dividends are:
(1) Petitioners failed to establish
that services were provided as required by section 162(a);
(2) payments were made in proportion to stockholdings; and (3) it
is unclear in what capacity RC, A. Gelabert, Santandreu, and
Segui were performing.various tasks.
A.
Eurotor
1.
Services
The preponderance of evidence is that substantial services
were provided to petitioners by various persons who also were
directly or indirectly owners of petitioners.
The Eurotor
shareholders were successful businessmen who possessed a myriad
of skills from management to financing.
The Eurotor
shareholders' ability to select key management employees,
suitable locations, and apply their knowledge of the tourist and
restaurant industries were services that were valuable.
The
shareholders' experience with an existing enterprise in Spain
which this venture was modeled added to.the value of the
n
- 83 -
services.
Santandreu and Segui spent considerable time in the
United States, assisting with operations and providing management
services.
Unlike dividends, the payment of management fees was
not dependent on earnings and profits.
The Eurotor shareholders
provided services, and, whether the business was profitable or
not, they were entitled to reasonable compensation for their
services.
See Achiro v. Commissioner, supra.
We believe the January 24, 1983, Eurotor contract with MTNV
was bona fide.
Although not in effect during the years in issue,
it corroborates petitioners' assertions.
v. Commissioner, supra.
document in 1983.
See Paula Constr. Co.
Allen testified that he drafted the
A list of documents that was kept at MTNV's
offices in 1983 included the January 24, 1983, contract.
(The
contract did not mention a franchise or refer to any other
contracts or agreements.)
The contract embodied Santandreu's
promise to the Eurotor shareholders that they would be
compensated for bringing the Medieval theme show to the United
States.
The management contract that was in effect during the
years 1n 1ssue was substantially a renegotiation of the
January 24, 1983, contract.
2.
Compensation in Proportion to Stockholdings
Respondent argues that a distribution of management fees in
proportion.taa stockholdings is indicative of disguised dividends.
"As the regulations explain, however, even payments made to
shareholders in proportion to their ownership are, as a general
rule, improper only if they are in excess of what is usually paid
- 84 -
for similar services."
Owensby & Kritikos, Inc. v. Commissi ner,
819 F.2d 1315, 1325 (5th Cir. 1987), affg. T.C. Memo. 1985-2 254
7;
sec. 1.162-7(b), Income Tax Regs.
Wë are guided by prior cases in reviewing the evidence tere.
If payments in dispute are contingent compensation pursuant to a
contract, the circumstances to be taken into consideration are
those existing at the date when the contract for services wa
made, not those existing at the date when the contract was
questioned.
American Foundry v. Commissioner, 59 T.C. 231, 244
(1972), affd. in part and revd. in part 536 F.2d 289 (9th Cir.
1976); sec. 1.162-7(b)(3), Income Tax Regs.
The past and present
financial condition of the company is relevant.
Home Interio s &
Gifts,
(1980).
Inc. v. Commissioner, 73 T.C. 1142, 1156
Evaluating the.compensation as a percentage of net income, ra her
than of gross receipts, is in most cases more probative becau e
it more accurately gauges whether a corporation is disguising the
distribution of dividends as compensation.
Owensby & Kritikos,
Inc. v. Commissioner, supra at 1325-1326.
The Eurotor/MTNV January 24, 1983, contract for management
services established a fee of 50 cents per patron.
The
attendance figures and profitability of the company were unkndwn
at the time of the contract because the Kissimmee castle did dot
open until December 1983.
The MSI contract, which was in eff ct
during the years in issue, was essentially a renegotiation of the
January 24, 1983, contract.
The MSI contract changed the fee
from 50 cents per client to a fee of 2 percent of gross
- 85 -
production.
Based on MSI's 1988 and 1989 tax years, during which
gross production was $11,338,915 and $12,714,857, respectively,
the renegotiation resulted in additional fees of approximately
$20,000' per year.
The Eurotor MANV/MDT management contract also had a fee of
2 percent of gross production.
Notwithstanding that the contract
was probably not ratified until 1987, the castle opened in 1986
and the operation's profitability was untested at the time the
fee was determined.
In Good Chevrolet v. Commissioner, T.C. Memo. 1977-291, this
Court addressed the reasonableness of compensation paid to two
employees of an automobile dealership.
The two employees held
100 percent of the corporation's stock.
The issue was whether
bonuses that constituted predetermined percentages of profits
were reasonable.
The facts that tended to support a finding of
excess compensation included:
The two shareholders controlled
the corporation's finances; the amount of net income paid out as
bonuses during the years in issue approximated 60 percent per
year; and the success of the business was due in part to
fortuitous economic conditions and not to altered or augmented
endeavors by them.
The facts that tended to support the
reasonableness of the compensation included:
The business was
extraordinarily successful, due in part to programs instituted by
the shareholders; the shareholders were astute, aggressive
businessmen; and, although a percentage of the profits was
determined before one shareholder had a controlling interest in
- 86 -
the corporation, that shareholder did not change the percentage
once he obtained control.
In reaching our conclusion, we considered that, "Though the
officers were also shareholders of the petitioner, they are
entitled to reasonable compensation for services actually
rendered."
Good Chevrolet v. Commissioner, supra (citing
Commercial Iron Works v. Commissioner, 166 F.2d 221, 224 (5th
Cir. 1948)).
Contingent compensation paid pursuant to a free
bargain between the parties before services are rendered should
be allowed as a deduction even though in the actual working o t
of the contract it may prove to be greater than the amount that
would ordinarily be paid.
Sec. 1.162-7(b)(3), ·Income Tax Reg .
The arrangement also may result in lesser compensation in les
successful years.
Finally, we noted "this is not a case in which
the controlling officers annually draw all, or virtually all, of
the profits of the business in the form of bonu 540es."
Good
Chevrolet v. Commissioner, supra; cf. Boyle Fuel Co. v.
Commissioner, 53 T.C. 162, 171 (1969); see Owensby & Kritikos,
Inc. v. Commissioner, T.C. Memo. 1985-267, affd
(5th Cir. 1987)
819 F.2d 1315
(the contracts did not create a situation where
virtually all of the taxable income was paid out as
compensation).
We concluded that compensation paid to
shareholder-employees constituting approximately 60 percent of
net income was reasonable.
supra.
Good Chevrolet v. Commissioner,
- 87 -
Here, as in Good: Chevrolet, the Eurotor shareholders
controlled the entity paying the management fees.
However, the
compensation that was paid to Eurotor as management fees under
both the MSI and MANV/MDT contracts, expressed as a percentage of
net income, was substantially below 60 percent:
MSI
MANV
MDT
1987
1988
1989
-6.2%
--
15.0%
-31.5%
4.7%
-3.5%
The Medieval Times companies successfully tapped into the
tourist markets in Florida and California, and the success was
due in part to the Eurotor shareholders' selection of locations
and employees.
The California management contract that
established a 2-percent-of-gross-production fee was effective
before the profitability of the business was known and was not
modified after the business became profitable.
The facts support the conclusion that the amounts paid to
the Eurotor shareholders were not in excess of compensation that
would be paid for similar services.
Therefore, that the payments
were made in proportion to stockholdings does not make the
payments improper.
Owensby & Kritikos, Inc. v. Commissioner, 819
F.2d at 1324; sec. 1.162-7(b), Income Tax Regs.
We are persuaded that the MSI and MANV/MDT payments made to
Eurotor as management and consulting fees during the years in
issue were reasonable and for services as required by section
162; therefore, the deductions will be allowed.
- 88 -
B.
Royal Catering
A. Gelabert was the 100-percent owner of RC.
5-percent owner in MANV/MDT.
RC was a
RC' s 1987 management agreement
ith
MDT, which called for RC to receive 5 percent of MDT' s gross
profits, was the vehicle through which A. Gelabert was to rec ive
his 5-percent ownership interest in MDT. .
It is undisputed that A. Gelabert provided valuable services
to the Medieval Times operation.
Petitioners state on brief
hat
A. Gelabert "was compensated primarily through the management
fees paid to Royal Catering, which he owned."
Pursuant to the
RC/MDT management agreement, MDT was to reimburse RC for amour.ts
RC paid as wages to RC employees, specifically A. Gelabert.
'Îhe
management agreement provided for RC to receive fees under the
contract for "services" and also to receive amounts as
reimbursement for wages paid.
amounts were not wages.
Therefore, the nonreimbursed
Petitioners have failed to substantia e
which, if any, amounts paid to RC were reimbursable wages.
We
conclude that the services that A. Gelabert provided to MDT,
through the RC/MDT management agreement, were to protect or
enhance A. Gelabert's investment in MDT.
Inc. v. United States, 592 F.2d 272
See Olton Feed Yard,
(5th Cir. 1979) .
RC had been used as a vehicle by petitioners on several
previous occasions.
MTNV loaned to RC $100, 000 and then paid t.he
interest on the loan,
RC was used to obtain visas for
A. Gelabert and Sans.
RC did not have its own books and records;
its ledgers were part of MANV/MDT' s ledgers during the years i
- 89 -
issue.
Petitioner MANV/MDT has not persuaded us that the
payments to RC were business expenses and not dividend payments
to A. Gelabert.
Because the payments to RC were not ordinary and
necessary business expenses, as required under section 162, they
were not deductible.
Accordingly, respondent's determination on
this issue will be sustained.
C.
A. Gelabert, Santandreu, and Segui
Petitioners argue that Santandreu and Segui were entitled to
compensation because they were directors of MANV and worked on
the expansion of the Medieval Times companies and that
A. Gelabert was entitled to compensation because of the services
he provided to MANV.
Respondent contends that petitioners have a "hat problem"
with regard to the payments to A. Gelabert, Santandreu, and Segui
because it is unclear why MDT made the payments.
We agree with respondent that petitioners have a "hat
problem".
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:
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, Lince,
MICV, Manver, MABV, MANV, MTBV, MTNV, Primavert, Protravol,
Roundabout, and Slider; and Segui--Calinvest, Futureprom,
Holiday, Inverspan, Lince, Manver, MTNV, Primavert, and TM.
The
- 90 -
individuals were working in several different capacities
concurrently, and it is unclear in which capacity they were
working at any particular time.
Additionally, the individuals
were aIso shareholders in many entities.
were shareholders in MANV and Eurotor.
shareholder in MANV.
Santandreu and Segui
A. Gelabert was a
If they were acting in their capacity as
shareholders, the services they provided to protect their
interests as shareholders are not deductible urider section 161.
Olton Feed Yard, Inc. v. United States, supra.
We conclude that
the amounts paid to A. Gelabert were wages, and the amounts paid
to Santandreu and Segui were dividends for the following reasons.
A. Gelabert was hired to run the castle.
He was in charge
of renovating the castle and getting the operation off the
ground.
He was entitled to payment for his services as an
employee of MANV.
The amounts paid to A. Gelabert were not
dividends because, as we have previously concluded, he was
receiving his dividends through RC.
Eurotor was entitled to receive compensation for the
management services it provided to petitioners.
In order to
provide those services, it had to have representatives workin
with petitioners.
Santandreu and Segui spent considerable time
in the United States assisting with operations and providing
management services.
We conclude that Santandreu and Segui we e
working in their capacity as Eurotor representatives; they wer
not entitled to additional compensation from petitioners.
additional payments they received were dividends.
The
Therefore,
he
- 91 amounts paid to Santandreu and Segui individually were dividends
for their interests as shareholders in MANV.
II.
Franchise Transactions and Royalty Fees
Petitioners deducted the franchise and royalty expenses on
their Federal tax returns as "ordinary and necessary" business
expenses under section 162(a).
Petitioners have elected to apply
the 1994 Intercompany Transfer Pricing Regulations (secs. 1.482-1
to 1.482-8, Income Tax Regs.) to each of the taxable years in
issue as permitted under sec. 1.482-1(j)(2), Income Tax Regs.
Petitioners argue that the deductions satisfy the section 482
regulations on valuation and that no allocation is justified.
They argue on brief that the "pivotal issue here is the value of
the intellectual property that was transferred to the
petitioners, not the nature of the transactions by which they
preserved their rights to use it."
Petitioners maintain that the
extraordinary profitability of the Medieval Times companies
confirms the economic substance of their arrangement with Manver.
Petitioners presented expert testimony and information on
alleged comparables to support the argument that the income that
petitioners attributed to the intangible was justified.
The
thrust of petitioners' position is that they could pay unlimited
royalties so long as they received an adequate rate of return;
and the reported and taxed income was an adequate rate of return
by comparison to various industry standards.
Respondent argues
and, for reasons appearing below, we agree that we need not
belabor or even discuss this evidence.
- 92 -
Respondent determined that the amounts that petitioners
deducted under section 162(a) as franchise and royalty payments
to Manver were not "ordinary and necessary" business expenses
under section 162(a).
Respondent's main contention is that the
transactions that were the basis for the deductions were not bona
fide arm's-length transactions at fair market value and that the
transactions had no economic purpose or substance.
Responden
further determined that the amounts deducted represented income
to nonresident alien individuals/foreign corporations and tha
distribution, apportionment, or allocation is necessary in or er
to prevent evasion of taxes and to reflect income clearly as
authorized under section 482.
On brief, respondent agrees with petitioners that
conceptually section 482 would apply because of petitioners'
common control, the shifting of income and deductions, and the
need to reflect income clearly.
Respondent contends, however
that there is no need to resort to allocations under section
82
because the Medieval Times companies owned the .intangibles that
they were purporting to license and there was no economic
substance to the transactions.
Section 482 permits respondent to make adjustments to
petitioners' Federal tax returns:
SEC. 482. ALLOCATION OF INCOME AND DEDUCTIONS AMONG
TAXPAYERS.
In any case of two or more organizations, trades,
or businesses (whether or not incorporated, whether or
not organized in the United States, and whether or not
affiliated) owned or controlled directly or indirectly
by the same interests, the Secretary may distribute,
- 93 -
apportion, or allocate gross income, deductions,
credits, or allowances between or among such
organizations, trades, or businesses, if he determines
that such distribution, apportionment, or allocation is
necessary in order to prevent evasion of taxes or
clearly reflect the income of any such organizations,
trades, or businesses.
In the case of any transfer (or license) of
intangible property (within the meaning of section
936(h)(3)(B)), the income with respect to such transfer
or license shall be commensurate with the income
attributable to the intangible.
Section 936(h)(3)(]B) defines intangible property:
(JB) Intangible property.--The term
"intangible property" means any-(i) patent, invention, formula,
process, design, pattern or knowhow;
(ii) copyright, literary, musical,
or artistic composition;
(iii) trademark, trade name, or
brand name;
(iv) franchise, license, or
contract;
(v) method, program, system,
procedure, campaign, survey, study,
forecast, estimate, customer list, or
technical data; or
(vi) any similar item,
which has substantial value independent of
the services of any individual.
Section 1.482-1(i)(5), Income Tax Regs., defines a
controlled taxpayer as follows:
(5) Controlled taxpayer means any one of two or
more taxpayers owned or controlled directly or
indirectly by the same interests, and includes the
taxpayer that owns or controls the other taxpayers.
* * *
- 94 -
In determining the true taxable income of a controlled
taxpayer, the standard to be applied in every case is that of a
taxpayer dealing at arm's length with an uncontrolled taxpayer.
Sec. 1 482-1(b), Income Tax Regs.
The "arm's-length" test
commonly associated with section 482 is equally applicable in
ascertaining the "ordinary and necessary" character of a paym nt
to a related party that is deducted under section 162(a).
French Co. v. Commissioner, 60 T.C. 836, 849 (1973).
R.T.
A
controlled transaction meets the arm's-length standard if the
results of the transaction are consistent with the results th¿t
would have been realized if uncontrolled taxpayers had engaged in
the same transaction under the same circumstances (arm's-leng h
result).
Sec. 1.482-1(b), Income Tax Regs.
Petitioners argue that the "White Paper", "A Study of
Intercompany Pricing Under Section 482 of the Code," I.R.S.
Notice 88-123, 1988-2 C.B. 458, referred to legislative rejection
of R.T. French Co.
The White Paper addressed only the view th t
a long-term fixed rate royalty agreement could not be adjusted
under section 482 based on actual events.
Notice 88-123, 1988 2
C.B. at 477. This Court has long recognized the use of an "arm slength" standard to determine the ordinary and necessary
character of a payment to a related party under section 162(a)
(and its predecessor, section 23(a)).
Differential Steel Car Âo.
v. Commissioner, 16 T.C. 413, 423-425 (1951); Granberg Equip.,
Inc. v. Commissioner, 11 T.C. 704, 713-714
Commissioner, T.C. Memo. 1963-14.
(1948); Nestle Co. v.
- 95 Section 482 sets forth two requirements with respect to
intangibles:
(1) A transfer or license of the intangible and
(2) the income received because of the transfer must be
commen 541urate
with the income attributable to the intangible.
Petitioners assert that there was a transfer of intangibles,
i.e., the Medieval Times concept from TM to Gatetown and from
Gatetown to Manver.
Petitioners further assert that, once Manver
owned the intangibles, MSI and MDT were obligated to enter into
licensing agreements: with Manver in order to use the Medieval
Times concept.
Petitioners' primary arguments begin at this
point and focus on whether the amounts paid under the licensing
agreements are commensurate with the income attributable to the
intangibles.
Petitioners rely on the section 482 regulations,
which provide several different methods to determine whether a
transaction is at arm's length.
The methods address the "income
attributable to the intangible" language of section 482.
Before we can ascertain if the income with respect to a
transfer is commensurate with the income attributable to the
intangible, however, we must first identify a transfer of the
intangible as required by section 482.
Petitioners' discussion
of whether or not a transfer of the intangible occurred is
cursory at best.
The essence of a transfer, as respects taxation, is the
passage of control over the economic benefits of property rather
than any technical changes in its title.
Commissioner, 308 U.S. 39, 43
Estate of Sanford v.
(1939); Burnet v. Guqqenheim, 288
- 96 -
U.S. 280, 287 (1933).
The word "transfer", as used in the tax
law, has its ordinary significance and means the handing ove
or
parting with property with intent to pass it, or certain rig
s
in it, 'to another, who becomes the transferee.
In re Gould's
Estate, 156 N.Y. 423, 51 N.E. 287, 288 (1898).
Inherent in the definition of transfer is the concept th t
the transferor must control or own the rights or economic
benefits that the transferor desires to transfer to the
transferee.
To establish that a transfer has occurred, we mu t
identify who owns the rights and economic benefits of the
property that is the subject of the transfer.
Section 1.482-
4 (f) (3) (ii) (B) , Income Tax Regs., defines ownership as followd:
(B) Intangible property that is not legally
protected. In the case of intangible property that is
not legally protected, the developer of the intangible
will be considered the owner. * * *. Ordinarily, the
developer is the controlled taxpayer that bore the
largest portion of the direct and indirect costs of
developing the intangible, including the provision,
without adequate compensation, of property or services
likely to contribute substantially to developing the
intangible. A controlled taxpayer will be presumed not
to have borne the costs of development if, pursuant to
an agreement entered into before the success of the
project is known, another person is obligated to
reimburse the controlled taxpayer for its costs.
* * *
Intangible assets that are legally protected include
patents, trademarks, and copyrights.
The Medieval Times
intangibles were not legally protected until the trademarks were
registered in California and Florida in 1987 and registered wit h
the U.S. Patent and Trademark Office in 1988.
We must ascertain who bore the largest portion of the
development costs of the Medieval Times "formula" .
Petitioner
- 97 -
argue that the formula was the intangible transferred for
arm's-length value.
The facts overwhelmingly support the
conclusion that MTNV, from 1983 through 1986, developed the
Medieval Times formula.
A. Gelabert was hired and paid by MTNV
to run the Florida operation.
MTNV paid the salaries of the
employees who were responsible for developing the Medieval Times
concept, including:
Stonecrow, who designed and produced the
costumes for the show; Bellows and Kudlacz, who developed the
marketing plans; and Galindo, who established the photography lab
and pioneered the use of group photographs.
The construction costs for the Florida castle were paid by
Inverspan.
Inverspan received the funds from a loan guaranteed
by the Spanish investors who were also the MTNV and Inverspan
shareholders.
The costs to modify the facility from 1983 through
1986 to reflect the ongoing development of MTNV were paid by
MTNV.
Those modifications included work on the kitchen, the
stables, the entry to the castle, and the addition of a medieval
village.
Additionally, MTNV had a contract to pay Eurotor for
management and consulting services.
The "Medieval Times" name was first used in the United
States in December 1982 when Castro filed an application for a
post office box in Kissimmee.
From 1982 until the purported
licensing agreements with Manver, MTNV conducted business using
the "Medieval Times" name and the "formula" without paying
compensation to any other person or entity.
Petitioners argue
- 98 -
that the agreements between MTNV and TM dated February 1, 19 254
3,
bound MTNV to compensate TM for the use of the intangibles.
The language in the two contracts between MTNV, Eurotor, and
TM, dated February 1, 1983, and January 20, 1983, is virtually
identical to the language in Forsyth's November 1986 draft letter
to Santandreu.
Forsyth's letter was a recap of a conversaticn
between Forsyth and Santandreu.
In the letter, Forsyth discussed
the franchise agreement, the script document, and the need to set
out TM's responsibilities as licensor of the Medieval Times
concept.
The letter stated that TM should include with its
duties assistance with the design of costumes, with training
horses and actors, and with quality control.
On cross-examination, Forsyth was asked about his notes
taken on or about May 20, 1986.
His testimony proceeded as
follows:
Q Okay. Did you understand at the time you made
these notes that there was an agreement to transfer
those intangibles?
A I don't know whether there was an agreement to
transfer the intangibles at that time.
Q Okay. Well, you indicated that if you had an
agreement you could prepare a document later and have
it signed effective as of the date of the agreement,
correct?
A
Correct.
Q Okay. Do you have a recollection at this
point, the effective date of this transfer of
intangibles?
A No, I don't know the effective date of the
transfer.
- 99 Q Okay. So if the effective date of the transfer
was prior to the time that you took these notes, then
would that indicate to you that you were advised that
there was an agreement in effect?
A
An agreement for which?
O
For the transfer of the intangibles?
A I can't comment.
understanding.
I
that was not my
Q It was not your understanding that there was an
agreement in effect at the time you made these notes?
A I'm not aware that there was
aware that there
was an agreement to transfer the intangibles at that
time.
Q
other?
Okay.
Were you not aware, one way or the
A One way or the other. I would
my assumption
at the time and now is that I was not aware of any
agreement to transfer.
Forsyth discussed a possible management contract, in
addition to the franchise agreement, and stated that the
management agreement must emphasize that the services provided in
the management agreement extend beyond the normal stewardship
functions that the shareholders may exercise.
The management
services that Forsyth suggested included providing detailed
advice on accounting and administration, financing, and personnel
selection.
Forsyth recommended a fee of 10 to 15 percent for the
franchise agreement and 2 percent for the management agreement.
C&L received unsigned copies of agreements dated January 20,
1983, and February 1, 1983, for the first time on December 12,
1986, a month after Santandreu received Forsyth's letter.
The
January 20, 1983, document stated that TM was to take "exclusive
-.100 -
charge of technical assistance, not management," and to
contribute the use of the name, trademark, handbook, or formula;
experience with respect to choreography, lights, sound, and the
making 'and maintaining of costumes and wardrobes; and quality
control.
TM was to receive as compensation 10 percent of MTNY's
gross production.
The February 1, 1983, agreement stated that Eurotor was
o
contribute experience in the management of companies, including
finance, administration, and personnel.
The ot|her documents
received by C&L on December 12, 1986, included management
agreements between Eurotor and MANV and Eurotor and MTNV dated
February 1, 1986, and August 1, 1986, respectively.
These
agreements also contained language identical to Forsyth's
November 1986 letter and provided for MANV and MTNV to each pay
Eurotor 2 percent of their gross production.
MTNV never paid TM for the use of the intangibles prior to
their agreements with Manver.
Petitioners argue that there were
no payments made because, pursuant to the agreements, MTNV was
not required to make payments to TM until the daily average
attendance at the Florida castle reached 700 patrons.
This
assertion is contradicted by petitioners' own evidence.
Petitioners' MTNV attendance figure for 1985 was 257,350, which,
divided by 365, equals 705 patrons per day, and no royalty
payments were made for 1985.
It is not credible that the similarity in language and fe s
in the 1983 agreements and the 1986 letter were purely
- 101 -
coincidental.
This is particularly so because the similar
language, and the concept of franchising, are absent from the
January 24, 1983, management contract between Eurotor and MTNV.
Additidnally, the agreements provided for licensing the use of
the trademarks, and there were no registered trademarks in 1983.
The January 24, 1983, contract was the only document that was
signed, and.Allen testified that he drafted the document in 1983.
The alleged draftsman of the other documents was Jose Luis
Fernandez (Fernandez) an "economist and tax adviser" who was only
beginning his professional business in 1982 and 1983.
Fernandez
was a relative of Segui, and Fernandez testified that Segui came
to him instead of a lawyer because "it was easier for him to
direct me."
Fernandez testified that he used the word
"franchising" in the contracts because Segui directed him to use
that specific word.
However, Kim testified that, prior to 1986,
the Medieval Times organization was not called a franchise.
Hokanson at LL did not form an opinion that the Medieval Times
transactions fell within the California Franchise Law until 1986,
at which time he advised A. Gelabert of that opinion.
Fernandez's testimony as to the dates of his drafts was not
credible.
We conclude that the January 20, 1983, and February 1,
1983, documents are a belated attempt by petitioners to
manipulate or manufacture the facts to fit the form suggested by
C&L.
Putting aside the unreliable documentation, we must consider
the substance of the relationship.
The MTNV shareholders brought
- 102 -
an idea from Spain to the United States.
proprietary concept.
It was not a
At the same time that MTNV was opening,
another group of investors could have opened a dinner theater
with a'medieval theme without infringing on the rights of TM.
The existence of similar shows, such as King Henry's Feast and
King Arthur's Tournament, is evidence undermining petitioners'
claims that the medieval dinner theater idea was uniquely
valuable.
The name "Medieval Times" did not exist prior to
MTNV's use of it in 1982.
If another group had trademarked tie
name before MTNV started to use it, TM would have had no recourse
because TM did not own the name.
TM did not have any recourse against MTNV for the use of the
name "Medieval Times" or for the use of the idea to open a
medieval theme dinner theater.
compensate TM.
Therefore, MTNV had no reason to
If TM and MTNV had not been related, MTNV would
not have agreed to compensate TM for the use of an intangible
that was not yet developed and that TM did not own.
Additionally, because TM did not own the intangibles, TM woul
not have been able to transfer the rights to the intangibles.
Other facts indicate that TM did not own the intangibles.
In the purported sale of the intangibles from TM to Gatetown,
Gatetown acquired the intangible rights of TM for $7,312 on
March 1, 1986 (the document is dated approximately 1 year earl,ier
than it was drafted).
For the fiscal year ended July 31, 1986,
MTNV's gross receipts were $7,048,767, and its taxable income was
$636,795.
Petitioners acknowledge the nominal consideration a d
- 103 -
explain on brief that, "since 80 percent of the Eurotor
shareholders also held Torneo stock, the only Torneo shareholders
who were being bought out were Mr. Rousselet and Mr. Celedonio"
(Celedónio).
Petitioners allege that Rousselet was compensated because he
was given two other companies to operate.and that Celedonio was
compensated by a 10-percent profits interest and manager position
in TM.
Other than Santandreu's testimony, there is no evidence
in the record to corroborate the allegations of compensation for
Rousselet and Celedonio.
Additionally, Celedonio was not an
original shareholder.of TM, and we do not know when or if he
became a shareholder.
When asked why TM sold the formula to
Gatetown for $7,312, J. Montaner testified:
"Well, my nephew
told me this was right, because in practice the people who are
selling it were actually also the people who were buying it."
Petitioners state on brief:
"it is undisputed that the Torneo-
Gatetown-Manver transactions were between largely related parties
and that the non-continuing Torneo shareholders were separately
compensated for their interests.
Thus, neither price is reliable
evidence of the value of the intangibles."
Petitioners' declaration that the price was an unreliable
measure of the value of the intangibles because the parties were
related undermines their position.
Every transaction that
occurred between TM, Gatetown, Manver, MTNV/MSI, MANV/MDT, etc.,
involved related parties because all or substantially all of the
shareholders in the companies were the same.
Extending
- 104 -
petitioners' analysis, the price in all of the transactions
between the parties would be unreliable.
We believe that the
subsequent sale of the intangibles from Gatetown to Manver fo::
$5.6 million not more than 3 months after Gatetown purchased 1;he
intangibles for $7,312 is evidence of the unreliability of tho
transaction price and evidence that the transactions were not at
arm's length.
The subsequent transactions that affected the years in issue
are based on these original transactions.
The attempt to cre(te
a chain of possession of the intangibles from TM to Gatetown t o
Manver is implausible for several reasons.
The foremost reason
is that MTNV, and not TM, owned the intangibles..
Additionally,
the documents were bac
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