Petition for Writ of Certiorari — Cannon v. Commissioner

Supreme Court brief1992

Ask Donna

What actually matters in this document.

Text

6 6 5 Suprane Court, U.S

; FILED

NO. |

en tH?

In the SPiGE QF THE CLERK

Supreme Court of the United States

OCTOBER TERM 1991

CHARLA GATES CANNON,

Petitioner,

versus

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

TOWNER SHIELDS LEEPER

JOHN LEEPER

Attorneys for Petitioner

LEEPER & LEEPER

661 Mesa Hills Drive

El Paso, Texas 79912

(915) 581-8748

A B Letter Service, Inc., 327 Chartres St., New Orleans, La. (504) 581-5555

QUESTIONS PRESENTED

The litigants in this income tax case tried and briefed

the case in the issues of whether the stipulated expenses

were deductible as business expenses or for the production

of income. The Tax Court disallowed the expenses on the

ground they were hobby losses. The Tenth Circuit affirm-

ed. The questions presented are:

Was it reversible error to sua sponte construe the hob-

by loss provisions in pari materia with those involving

business expenses?

Should the case be remanded to the Tax Court to af-

ford petitioner the opportunity to offer evidence on the

hobby loss issue?

TABLE OF CONTENTS

Question Presented

Table of Contents

Table of Authorities

Citations to Opinion Below

Jurisdiction

Statement of the Case

Reasons Why the Writ should be granted

Conclusions and Prayer

APPENDIX:

A. STATUTES INVOLVED

B. DECISION OF THE TAX COURT

C. OPINION OF THE TAX COURT

D. OPINION OF THE TENTH CIRCUIT

E. DENIAL OF PETITION FOR REHEARING

Page

A-49

F. SENATE COMMITTEE REPORT ON SECTION

183

A-51

ill

TABLE OF AUTHORITIES

CASES

Ah Pah Redwood Co. v Commissioner (9th Cir 1957)

276 U.S. 145, 6 AFTR 7358

Baird v Commissioner (3d Cir 1970) 438 F2d 490, 26

AFTR 2d 70-5799

Bingham’s Trust v Commissioner (Sup Ct 1945) 325

U.S. 33 AFTR 842

Clark v Commissioner 266 F2d 698. 3AFTR 2d 1333

(9th Cir 1959)

Clifford v United States

Edison Securities Corporation (4th Cir) 78 F2d 85.

16 AFTR 307

Hormel v Helvering (Sup Ct 1941) 312 U.S. 552. 25

AFTR 1198

Kornhauser v United States (Sup Ct 1928) 276 U.S.

145, 6 AFTR 7358

Little v Commissioner (1st Cir 1960) 273 F2d 746, 5

AFTR 2d 492

Tex-Pen Oil Co. v Commissioner 83 F2d 518 17

AFTR 518 (3rd Cir 1936)

Commissioner v Transport Manufacturing and

Equipment Co., (8th Cir 1973) 478 F2d 731. 31

AFTR 2d 73-1247

PAGE

6,5

]

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM 1991

CHARLA GATES CANNON,

Petitioner

versus

COMMISSIONER OF INTERNAL REVENUE,

Respondert.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

Petitioner Charla Gates Cannon respectfully pray a

Writ of Certiorari issue to review the Judgment of the

Tenth Circuit Court of Appeals entered into this pro-

ceeding on November 15, 1991 and the denial of a Petition

for Rehearing on January 13, 1992.

CITATIONS TO OPINIONS BELOW

The United States Tax Court entered its opinion

reported in Tax Court Memo 1990-148. The Tenth Circuit

Court of Appeals entered its opinion which has not

reported to date.

JURISDICTION

Petitioner appeals from the judgment of the Tenth

Circuit decided November 15, 1991. Petitioner’s petition

for rehearing was denied on January 13, 1992. Jurisdiction

of this Court is invoked under 28 U.S.C. 1254 and 2101 and

Supreme Court Rule 10.

STATEMENT OF THE CASE

This case involves a taxpayer’s treatment of losses

incurred in connection with a Mexican geld and silver min-

ing venture. In 1973, the taxpayer, Charla Cannon, joined

a limited partnership (‘‘Vemco’’) that was formed ‘‘to

engage in the business of land development, exploration,

mining and ore processing both in the United States and

foreign countries.’’ The Taxpayer provided Vemco with the

funds necessary to conduct its business operations.

Vemco decided to invest in the Mexican venture at

issue in this case in reliance upon the findings of an ex-

perienced miner who explored the sites and an engineer

who analyzed and reported on the mining properties.

Because Mexican law prohibits non-Mexican nationals or

corporations from acquiring a majority interest in Mexican

mining concessions, Compania Minera San Jose de Man-

zanillas, S.A. (‘‘Manzanillas’’), a Mexican corporation, held

the mining concessions, and Vemco became a forty-nine

percent shareholder in that corporation. In 1978, however,

Vemco discovered that the president of Manzanillas had

been embezzling, and the mining concessions were transfer-

red to Memco, a different Mexican corporation. Although

the taxpayer, through Vemco, expended over $800,000 for

exploration and development of the mines, Memco never

operated at a profit. Vemco did not report any income from

mining for the years involved in this lawsuit, nor did it

receive any dividends.

The taxpayer deducted her distributive share of the

partnership losses claimed by Vemco on her federal income

tax returns for 1976, 1977, 1978, and 1979. The Commis-

sioner of Internal Revenue disallowed these deductions on

I EE_ OO

the grounds that the tazpayer did not establish that these |

amounts constituted ordinary and necessary business ex- |

penses or were for an activity entered into for profit or for |

the production of income.

The Tax Court agreed with the Commissioner’s deci-

sion to disallow the deductions, but found the expenditures

to be nondeductible under section 183 of the Internal

Revenue Code. Because the Tax Court decided the case on

the basis of a section that neither party raised explicitly,

the taxpayer filed a motion for reconsideration, which was

denied. The taxpayer appealed to the Tenth Circuit which

affirmed holding:

‘Here, the taxpayer contends that the Tax Court er-

roneously decided this case on the basis of a theory and

Code provision (lack of profit motive and section 183) that

neither party considered or raised. thereby surprising and

prejudicing the taxpayer. According to the taxpayer, only

three Code sections were at issue: sections 162, 212, 616.

We disagree. Section 183 is interrelated to sections 162 and

212, profit motive being the common underlying theme. In-

deed, as discussed infra, these provisions even reference

each other. Accordingly, we find that the taxpayer in this

case was adequately put on notice, was not prejudiced, and

should not have been surprised.’’ The Tenth Circuit affirm-

ed and further refused to remand the case to the Tax Court

for consideration and consolidation with subsequent years

involving the same issue pending in Docket Number

4389-91.

REASONS WHY THE WRIT SHOULD BE GRANTED

The Tenth Circuit's Statutory construction theory

that the sections of the Internal Revenue Code here in-

volved are ‘“‘naturally”’ interrelated, conflicts with the

decisions of other Circuits.

Without congressional or judicial authority the

Tenth Circuit has erroneously manufactured a ‘‘natural”’

implication that the interpretation of two sections of the

I.R.C., Section 162 defining business expenses, and Section

212 involving expenses for the production of income, are

naturally to be construed by considering the elements of

the profit motive. Consideration of the origin and purpose

of three statutes reveals the Tenth Circuit’s error in

statutory construction.

Section 162 was enacted in 1918 as Section 214

allowing as deductions ‘“‘all the ordinary and necessary

business expenses paid or incurred during the taxable year

in carrying on any trade or business’’ and interpreted by

this Court in Kornhauser v. U.S. (Sup Ct 1928) 276 U.S.

145, 6 AFTR 7358 allowing a deduction for attorney fees

between partners. Section 212 was added to the Code in the

Revenue Act of 1942 as section 23(a)(2) to allow deductions

for non-business expenses incurred for the production of in-

come and interpreted by this Court in Bingham’s Trust v

Comm (Sup Ct 1945) 325 U.S. 365, 33 AFTR 842 allowing

a deduction for attorney’s fees to a trust carrying on no

business. This Court held the two statutes, 162 and 212 are

to be construed with reference to each other. The ap-

plicability of these statutes was litigated and briefed by the

parties in the instant case.

However, the Tax Court, with affirmance by the

Tenth Circuit, sua sponte held Section 183 of the Internal

Revenue Code was decisive. Section 183 was enacted in

1969 to disallow hobby losses in excess of gross income.

The accompanying Senate Report to H.R. 13270, lst

Section 103 is set forth in Appendix E the pertinent part

of which follows:

‘The committee is concerned, however, that re-

quiring a taxpayer to have reasonable expectation” of

profit may cause losses to be disallowed in situation

where an activity is being carried on as a business

rather than as a hobby. Accordingly, the committee

has modified the house bill to provide that in deter-

mining whether losses from an activity are to be allow-

ed, the focus is to be on whether the activity is engag-

ed in for profit rather than whether it is carried on

with a reasonable expectation of profit. This will pre-

vent the rule from being applicable to situations where

many would consider that it is not reasonable to ex-

pect an activity to result in a profit even though the

evidence available indicates that the activity actually

is engage in for profit. For example, it might be argued

that there was not a “reasonable”’ expectation of pro-

fit in the case of a bona fide inventor or a person who

invests in a wildcat oil well. A similar argument might

be made in a case of a poor person engaged in what ap-

pears to be an inefficient farming operation. The com-

mittee does not believe that this Provision should ap-

ply to these situations on that the House intended it

to so apply, if the activity is engaged in for profit.

Consequently, as passed, Section 183(c) expressly ex-

cluded items deductable as business expenses under Sec-

tion 162 or for the production of income under Section 212.

The statute provides: “For purposes of this section, the

term ‘‘activity not engaged in for profit’’ means any activi-

ty other than one with respect to which deductions are

allowable for the taxable year under section 162 or under

paragraph (1) or (2) of section 212.” No changes were made

in sections 162 or 212. Thus the Tenth Circuits holding that

three sections are entwined was patently erroneous.

Neither Section 162 or 212 refer to or are limited by Section

183; the latter’s applicability kicks in, if at all, only if the

former sections are not applicable. This case was litigated

under one theory and erroneously decided and affirmed

under an entirely different issue.

Other circuit courts have uniformly rejected the

Tenth Circuit’s approach. The Eight Circuit in Comm v

Transport Manufacturing and Equipment Co (8th Cir 1973)

478 F2d 731, 31 AFTR 2d 73-1247 approved the Tax

Court’s refusal to consider an issue not raised at trial,

stating, ‘“The Commissioner should notify the taxpayer of

the particular Code section, regulation or theory involved

in a case to avoid prejudice to the taxpayer.’’ The Third Cir-

cuit in Baird v. Comm (8rd Cir 1970) 438 F2d 490, 26

AFTR2d 70-5799 held: ‘‘Although the Commissioner may

suggest additional theories of liability during the hearing,

it is impermissible for the Tax Court to decide the case on

an issue other than that explicity tendered without

reasonable notice to the taxpayer’ (Emphasis Added). In

like manner the Ninth Circuit in Ah Pah Redwood Co v

Commissioner (9th Cir 1957) 251 F2d 163, 1 AFTR2d 456

reversed and remanded the case where neither of the par-

ties had addressed the issue although the Tax Court had.

In Edison Securities Corporation the 4th Circuit in an opi-

nion reported at 78 F2d 85, 16 AF'TR 307, expressed the

proper judicial stardard when the trial court sue sponte

raised the theory on which the case was decided, stating:

‘In the pending case, however, the new matter

was not introduced by the parties but by the Board

itself, and the subsequent course of the proceedings

should have been shaped with this circumstance in

mind. A sharp issue was raised as to a point upon

which the parties had theretofore agreed, and

although some evidence bearing on the subject had

been put in the record in connection with the other

transactions, it was obviously inadequate for the pur-

pose now under discussion, for the Board itself said

that it was difficult to tell from the available facts

what had taken place. In this emergency, the Board

might well have ordered a rehearing upon its own mo-

tion, and in any event, should have granted the Com-

missioner’s motion to that end.”’

Furthermore, allocation of the burden of proof with

regard to the new theory would be necessary as neither par-

ty has ever raised the issue except the Tax Court itself.

Clark v Commissioner, 266 F2d 698, 3 AFTR 2d 1333 (9th

Cir. 1959); Tex-Penn Oil Co. v Commissioner, 83 F2d 518,

17 AFTR 518 (3rd Cir. 1936) (‘In view of these changes of

front, we submit that any presumption of correctness

which originally attached to the Commissioner’s formal

determination has now disappeared completely’’).

The Tenth Circuit has thus created a confusing

precedent, likely to generate further confusion among the

other Circuits. It is a precedent directly at odds with the

prior appellate decisions.

The decision below affirming the Tax Court’s decision

rather than remanding the proceeding conclusively

denied petitioner her day in court, a fundamental

injustice.

In its opinion the Tenth Circuit expressly

acknowledged that Section 183 was not considered by the

litigants. Rather than outright reversing the Tax Court the

tenth Circuit applied Section 183 and the nine factors listed

thereunder in Treasury Regulation 1.183-2(b) concluding

that were it considering the issue de novo it might well

have reached a different conclusion, however, the Tax

Court’s finding of fact was not clearly erroneous. All of this

without petitioner presenting evience of the Section 183

factors.

If the Supreme Court cencludes this case should not

be reversed, it is well resolved under its own standards that

the case should be remanded to afford petitioner the oppor-

tunity to present evidence directed towards Section 183. In

Hormel v Helvering (Sup Ct 1941) 312 U.S. 552, 25 AFTR

1198, the issue related to the definition of income. Subse-

quent to the trial court proceeding the Supreme held such

trust income was taxable in Clifford v. U.S. However, the

Supreme Court remanded Hormel to the trial court to allow

the taxpayers to present evidence on the issue, stating,

‘Under these circumstances we do not feel that petitioner

should be foreclosed from all opportunity to offer evidence

before the Board on this issue, however remote may be his

chance to take his case out of the Clifford rule.”

This principle of jurisprudence was well expressed by

the Phird Circuit in Baird v Commissioner (3d Cir 1970)

438 F2d 490, 26 AFTR2d 70-5799 and in the First Circuit

in Little v Commissioner (lst Cir 1960) 273 F2d 746,

5AFTR2d 492. In Baird the Court remanded for considera-

tion of the new issue. In Little the Court held that remand-

ing would be appropriate to allow the taxpayer to introduce

evidence on the new theory advanced by the government,

however, in oral argument appellant’s attorney conceded

no additional evidence was available. In the instant case

appellant has ample evidence to respond to the Regulations

nine factors, she simply seeks the opportunity to do so.

In view of the conflict of the decision below with the

past decisions of this Court, the Supreme Court may wish

to consider summary reversal.

CONCLUSIONS AND PRAYER

Because of the importance and broad application of

these issues in Federal tax cases, the petitioner prays that

this Court grant a Petition of Certiorari to the United

States Supreme Court.

Respectfully submitted,

TOWNER SHIELDS LEEPER

A-l

APPENDIX A

SEC. 162. TRADE OR BUSINESS EXPENSES.

(a) In General.—There shall be allowed as a deduction

all the ordinary and necessary expenses paid or incurred

during the taxable year in carrying on any trade or

business, * * *

* * * * *

SEC. 183 [as added by Sec. 213(a), Tax Reform Act

of 1969, Pub. L. No. 91-172, 83 Stat. 487].

ACTIVITIES NOT ENGAGED IN FOR

PROFIT.

(a) General Rule.—In the case of an activity engaged

in by an individual or an electing small business corpora-

tion (as defined in section 1371(b)), if such activity is not

engaged in for profit, no deduction attributable to such ac-

tivity shall be allowed under this chapter except as provid-

ed in this section.

(b) Deductions Allowable.—In the case of an activity

not engaged in for profit to which subsectior. (a) applies,

there shall be allowed—

(1) the deductions which would be allowable

under this chapter for the taxable year without regard

to whether or not such activity is engaged in for profit,

and

(2) a deduction equal to the amount of the deduc-

tions which would be allowable under this chapter for

the taxable year only to the extent that the gross in-

come derived from such activity for the taxable year

exceeds the deductions allowable by reason of

paragraph (1).

A-2

purposes of this section, the term “‘activity not engaged in

for profit’’ means any activity other than one with respect

to which deductions are allowable for the taxable year

under section 162 or under paragraph (1) or (2) of section

212.

(d) Presumption.—If the gross income derived from

an activity for 2 or more of the taxable years in the period

of 5 consecutive taxable years which ends with the taxable

year exceeds the deductions attributable to such activity

(determined without regard to whether or not such activity

is engaged in for profit), then, unless the Secretary or his

delegate establishes to the contrary, such activity shall be

presumed for purposes of this chapter for such taxable year

to be an activity engaged in for profit. In the case of an ac-

tivity which consists in major part of the breeding, train-

ing, showing, or racing of horses, the preceding sentence

shall be applied by substituting the perior of 7 consecutive

taxable years for the period of 5 consecutive taxable years.

* * * * x

SEC. 212 EXPENSES FOR PRODUCTION OF

INCOME.

In the case of an individual, there shall be allowed as

a deduction all the ordinary and necessary expenses paid or

incurred during the taxable year—

(1) for the production or collection of income;

(2) for the management, conservation, or

maintenance of property held for the production of in-

come; or

(3) in connection with the determination, collec-

tion, or refund of any tax.

A-3

APPENDIX B

COPY

UNITED STATES TAX COURT

CHARLA GATES CANNON, )

)

Petitioner, )

)

) Docket No.

) 2261-85

COMMISSIONER OF IN- )

TERNAL REVENUE, )

)

Respondent. )

DECISION

Pursuant to the opinion of the Court filed March 20,

1990, and incorporating herein the facts recited in the

respondent’s computation as the findings of the Court, it is

ORDERED and DECIDED: That there are deficien-

cies in income taxes due from the petitioner for the taxable

years 1978 and 1979 in the amounts of $120,334.60 and

$101,980.00, respectively.

(Signed) W.M. DRENNEN

Judge

Entered: JUL 10 1990

A-4

COPY

UNITED STATES TAX COURT

CHARLA GATES CANNON, )

)

Petitioner, )

)

) Docket No.

) 9671-82

COMMISSIONER OF IN- )

TERNAL REVENUE, )

)

Respondent.

DECISION

Pursuant to the opinion of the Court filed March 20,

1990, and incorporating herein the facts recited in the

respondent’s computation as the findings of the Court, it is

ORDERED and DECIDED: That there are deficien-

cies in income taxes due from the petitioner for the taxable

years 1976 and 1977 in the amounts of $155,221.20 and

$244,581.83, respectively.

(Signed) W.M. DRENNEN

Judge

Entered: JUL 10 1990

A-5

APPENDIX C

T. C. Memo. 1990-148

UNITED STATES TAX COURT

CHARLA GATES CANNON, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

DOCKET NOS. 9671-82, 2261-85.

Filed March 20, 1990.

Towner Leeper, for the petitioner.

John F. Eiman, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

DRENNEN, Judge:! In two separate notices of defi-

ciency, respondent determined deficiencies in petitioner’s

income tax for the taxable years and in the amounts shown

below:

Year Amount

1976 $156,531

1977 245,576

1978 123,155

1979 106,628

1 This case was assigned and deemed submitted to J udge Drennen by

order dated June 6, 1989.

A-6

Petitioner filed two petitions, one for the years 1976

and 1977 (docket No. 2671-84) and one for the years 1978

and 1979 (docket No. 2261-85). The issues in both dockets

were similar so the cases were consolidated for trial, briefs,

and opinion.

The parties filed stipulations of facts and the facts

stipulated therein are so found.

After concessions by petitioner, the remaining basic

issue is whether petitioner is entitled to deduct amounts of

money she allegedly paid, through Vemco, a limited part-

nership in which she was a limited partner, in connection

with a gold and silver mining venture in Durango, Mexico,

during each of the years at issue. More specifically, the

issues are:

(1) Whether the mining venture was an activity not

engaged in for profit by and through Vemco within the

meaning of section 183(a);2

(2) Whether the funds advanced to two Mexican cor-

porations, by and through Vemco, were nondeductible

shareholder contributions to the Mexican corporations or

were deductible expenses of a joint venture between Vemco

and the Mexican Corporations;

2 All Rule references are to the Tax Court Rules of practice and Pro-

cedure. All section references are to the Internal Revenue Code of 1954,

as amended and in effect for the years at issue.

A-7

(3) Whether amounts paid by Vemco to persons other

than the Mexican corporations in connection with the ex-

ploration, development, and operations of the mining con-

cessions constituted nondeductible capital contributions to

the Mexican corporations;

(4) Whether the expenditures, if not capital contribu-

tions, were paid in connection with mining development

(section 616 IRC) or mining exploration (section 617);

(5) Whether all of the aforementioned expenditures

were ordinary and necessary;

(6) Whether petitioner has substantiated all of the

amounts and the nature of the aforementioned expen-

ditures; and

(7) Whether the application of section 482 reduces

Vemco’s (and petitioner’s distributive share of) claimed in-

ventory loss to zero for the taxable year 1976.

FINDINGS OF FACT

Petitioner, Charla Cannon, was a widow who lived in

Denver, Colorado. She had a large annual income, primarily

from various trusts established by her family, and from her

deceased husband's estate, and various other benefits pro-

vided under bonus and pension plans by her deceased hus-

band’s former employer, Beatrice Foods Co. She had no

education or experience in mining or engineering, except

what she might have gleaned from her father, who was a

mining engineer. She was 67 years of age at the time of trial

in 1986. She received a junior college education at Benn-

ington College in New York. She was engaged in several

A-8

businesses prior to becoming involved in Vemco, including

Cannon Aeronautical Center, raising sheep in Wyoming, a

health spa for women, and selling helicopters in Colorado.

In 1973 petitioner became involved with a limited

partnership, Vemco, in which she was a 54 percent limited

partner. Vemco was a Texas limited partnership formed by

Ramon Perez Madrid. The limited partnership was

reconstructed under the same name in 1975. The limited

partnership then consisted of Hersey W. Young, Jr. and

Harold B. Young, general partners, and Charla G. Cannon,

H. R. Chrisman, M.D., and Carl W. Weaver, limited

partners.

The limited partnership agreement executed in 1975

set forth the purpose for Vemco which was ‘“‘to engage in

the business of land development, exploration, mining and

ore processing both in the United States and foreign coun-

tries.’’ This limited partnership agreement was amended

again as of January 1, 1978. It recited that subsequent to

the establishment of the partnership it needed additional

funds to conduct its business operations, and Cannon had

provided those funds; also that Cannon was willing to ‘‘pro-

vide further contributions to the partnership as requested

by the general partner’’ provided the agreement was ex-

ecuted. It stated further that because of the agreement of

Cannon to contribute additional capital to the partnership

while the other partners were not contributing a significant

additional capital or services, it was agreed that the alloca-

tion of profits of the partnership, as well as the proceeds in

the event of sale or disposition of the partnership assets,

should be allocated as follows:

Name Percentage

Charla G. Cannon 45%

Hersey W. Young, Jr. 30%

H. R. Chrisman, M.D. 9%

A-9

Carl W. Weaver 8%

Harold B. Young 8%

It was also agreed that the annual expenses and

losses of the partnership would continue to be allocated to

Cannon insofar as her capital account permitted. All of the

expenses of the mining ventures, which were paid by peti-

tioner through Vernco, were allocated to petitioner during

the years here involved. Hersey W. Young, Jr. was

designated to be the sole general partner with Harold

Young, Cannon, Weaver, and Chrisman being limited part-

ners. Harold B. Young resigned as a general partner.

In about 1970 Madrid acquired all the mining conces-

sions for three mining claims, Ampl. de San Jose, San Jose,

and Tres de Mayo, which were located in Sierra Madre Oc-

cidental Mountain range in the State of Durango, near the

village of Manzanillas, in the Republic of Mexico. Madrid

started working these claims prior to 1973.

The three San Jose mines were located in very moun-

tainous country, near Durango, Mexico, at an elevation of

6,000 to 6,500 feet above sea level. The terrain is rough and

the hillsides are very steep and roads are on a contour.

Manzanillas is the nearest village. A very primitive road

connecting Manzanillas and Topia, extending about 35

kilometers in length, was in place in 1973. The mines had

been opened and worked by hand through shafts and tun-

nels. Gold and silver were found in veins extending

underground.

Carl Weaver, an experienced miner and a limited

partner in Vemco, entered into an agreement with Madrid

in 1973 whereby Weaver paid Madrid $300 per month for

the right to conduct exploration activities for a limited

time at the site of the Madrid mining concessions. In

return, Madrid obligated himself to transfer the mining

concessions to a Mexican mining corporation at Weaver's

request. After spending approximately 30 days at the

A-10

mining site, Weaver prepared and submitted a report on

the San Jose mining properties to Hersey Young, Vemco’s

general partner and a long time business associate of peti-

tioner. In his report, Weaver estimated that the mine had

been in operation since 1913 and that the ore in the mine

(gold and other metals) was obvious, being exposed in the

face of the mine. Weaver estimated that with proper

development the mines had a potential production of 50

tons per day, although the small, very primitive mill on the

property could not mill more than three tons in 24 hours.

Weaver recommended the on-site installation of a larger

capacity mill because the cost of freight to transport ore to

the nearest smelter was about $100 per ton. Weaver also

reported that the per ton ore values of various ore samples

taken from the Taonita vein (located approximately one-

haif mile south of the San Jose mine) averaged between 0.7

and 1.0 ounces of gold and 9.0 ounces of silver.

Vemco’s decision to invest in the mining concessions

was based on Weaver’s findings and on the findings of an

engineer, Henry P. Ehrlinger (deceased at the time of the

trial), whom Young retained to analyze and report on the

mining properties. Ehrlinger was a professor of mining and

engineering at the University of Texas at El Paso with

much experience in mining activities in Mexico.

Ebrlinger visited the mine and subsequently sent

Ralph Wilcox, Jr., then a graduate geology student at the

University of Texas at E] Paso, to the location of the min-

ing claims. Wilcox prepared a report, dated April 1975,

which included the assay results of the ore samples taken

from the areas in which Manzanillas Corporation held min-

ing concessions. In his discussion of Taonita, Wilcox

revealed the following assay results of certain ore samples:

A-11

Ounces of Ounces of

Description Gold Per Ton Silver Per Ton

Channel sample 0.04 0.76

Channel sample 0.28 6.04

Quartz vein 0.04 0.60

The report also included a discussion of the Tres de

Mayo mine and contained the following assay results of

three channel samples taken at or near the mine:

Ounces of Ounces of

Description Gold Per Ton Silver Per Ton

N 1 Entrance,

first level 0.34 3.16

N 2 Second level,

rear 0.04 0.58

N 3 Third level,

rear 0.96 13.18

Wilcox’s report also included the following com-

ments regarding the mill located below Manzanillas: ‘At

current crushing capability, the mill can process about one

ton per day with about 60% recovery of precious metals.

The crusher is old and failing.”’

Ehrlinger prepared a mining report, dated May 1975,

which included Wilcox’s findings. Ehrlinger’s report con-

tained profit projections based on 50 tons of ore mined dai-

ly and a respective gold and silver ore grade of 0.70 and 9.0

troy ounces per ton of ore mined. Total monthly expenses

were projected at $99,011.68. Of these monthly expenses

only one, income taxes of $18,117.68, varied with changes

in profitability. All other expenses, fixed or variable, were

unaffected by changes in the precious metal ore grade per

ton of ore mined. Ehrlinger’s report projected a monthly

A-12

ore mining operationg rate of 1,200 tons and a ‘“‘net

calculated monthly profit’? of $50,172.32 if properly

exploited.

Ehrlinger’s report also contained a copy of the El

Paso Chemical Laboratories report addressed to Ehrlinger.

The El Paso Chemical Laboratories report contained the

assay results of 12 ore samples, partially reproduced below:

RESULTS

Gold Silver

Sample Designation oz/ton oz/ton

N-1l RW-T-14 0.04 0.60

N-1l RW-N-1 0.34 3.16

N-1l RW-M-19 0.01 0.33

N-1 RW-T-10 0.03 0.49

N-1 RW-T-15 0.04 0.60

N-1l RW-T-21 0.28 6.04

N-1l RW-F-1 0.03 0.63

N-1 RW-M-24 0.01 0.33

N-l RW-N-3 0.96 13.18

N-1 RW-N-2 0.04 0.58

N-1l RW-T-8 0.04 0.46

N-1l RW-T-13 0.04 0.76

Ehrlinger’s report further included various mineral

descriptions, prepared by Wilcox, of the 12 ore samples, in-

cluding the location from which they were extracted, most

of which were from either Tres de Mayo or Taonita.

Petitioner read both Weaver’s and Ehrlinger’s

reports. Petitioner had known Weaver for some time and

had confidence in his metallurgical knowledge. She read his

A-13

report on the San Jose mining properties and agreed to

make an investment therein. After petitioner read Ehrl-

inger’s report, which predicted a net profit of $50,172.32

per month if the mines were properly developed with an

adequate mill, she was willing to invest more in the project.

Vemco also became interested in the mining conces-

sions as a potential investment. Vemco entered into an

agreement with Madrid that Madrid would put his mining

interests into a corporation or partnership and that Vemco

would put up the money to cover the costs of defining and

developing the mines, which would be repaid first out of the

profits from the mine with the balance of the profits being

divided equally between them.

After petitioner learned from her Mexican legal

counsel that Mexican law prohibits non-Mexican nationals

or corporations from acquiring a majority interest in Mex-

ican mining concessions, the interested individuals decided

that a corporate ownership was the legal mechanism which

would best facilitate indirect ownership of the mining con-

cessions. Madrid later transferred his mining concessions

to a Mexican corporation, known as Compania Minera San

Jose de Manzanillas, S.A. (Manzanillas). Subsequent to the

transfer Vemco became a 49 percent shareholder in Man-

zanillas. The remaining 51 percent was issued to Mexican

nationais. However, because of further Mexican law re-

quirements, the stock representing Vemco’s 49 percent was

issued in the name of petitioner, and Hersey W. Young, Jr.,

for the benefit and on behalf of Vemco.

Madrid was president of Manzanillas until 1978.

Madrid supervised the mining and milling activities of

Manzanillas at the site of the mining claims. He testified

that during the time he worked the claims all the extraction

was done by hand. Madrid sold in his own name and in the

A-14

name of Manzanillas gold and silver extracted from the

claims. During 1974-1978, Madrid deposited at least

$47,288 of total sale proceeds either into his personal or

Manzanillas’ bank accounts. After this embezzlement was

discovered, Young ‘“‘fired’’ Madrid in 1978. Subsequently,

Young successfully brought suit against Madrid to recover

these amounts.

In 1976 and 1977, Vemco, acting through Young,

contracted with third parties for the construction of roads

and tunnels on the sites of the mining concessions and paid

for the work with its own funds. It also contracted with

Juan Sanchez to explore, repair and prepare the mining

property of the Manzanillas’ company. These contract ex-

penditures were claimed by Vemco as _ exploration-

development expenses, and totalled $165,827 in 1976,

$335,584 in 1977, $180,000 in 1978, and $125,460 in 1979.

In 1978 Memco S.A. de C.V. (Memco), was formed

and the owner of Mexican mining concessions adjacent to

the Madrid concessions, Raul Olguin Lopez (Lopez), subse-

quently transferred his mineral interests to Memco. Lopez

was the president of Memco. Vemco was granted an option

to acquire 49 percent of Memco’s stock (Class B) in ex-

change for an agreement to explore the mining claim. The

remaining 51 percent of Memco’s stock (Class A stock) was

subscribed for by Mexican nationals. On the same date

Vemco contracted with Sanchez for exploration of the min-

ing claim at a cost not to exceed $180,000. Memco was to

reimburse Vemco for the cost of exploring the mine with

the profits earned from Memco’s operations. Memco never

operated at a profit.

There was never any core drilling on any of the above

mentioned mining claims. A rather basic procedure was

used to extract and separate the gold from the mines.

A-15

Activity at the mines was curtailed, to some extent, after

it was discovered in 1978 that Madrid had been selling the

ore for his own account.

Romelia Carpenter has been nvolved in the actual

preparation of Vemco’s tax returns since 1978. Carpenter

has also prepared various financial schedules of Vemco’s

accounting data relating back to 1973. At trial, Carpenter

testified that, when available, she used source documents

in preparing the financial schedules. But in certain situa-

tions, payments made under contract did not flow through

Vemco’s regular checking account. In those situations,

Carpenter used the contract itself as a source document

and relied upon oral verification that payment thereunder

had been made.

Vemco did not report any income from mining on any

of its tax returns for the years here involved. Neither Man-

zanillas nor Memco has ever paid a dividend to Vemco.

The parties have stipulated that Vemco paid or in-

curred certain expenses in the years 1976, 1977, 1978, and

1979, which produced the losses claimed by Vemco in its

tax returns for those years. Petitioner, by virtue of the

limited partnership agreement, claimed these losses as

Schedule E partnership losses. In his notices of deficiency,

respondent determined the extent to which the amounts

claimed by petitioner, through Vemco, should be disallow-

ed. Those amounts disallowed by respondent totalled

$187,173.96 for 1976, $354,608.29 for 1977, $214,078.00 for

1978, and $152,415.00 for 1979. The principal amounts

disallowed by respondent were deductions claimed for each

of those years for ‘exploration development”’ expenses

which totalled $165,827.35 for 1976, $335,584.16 for 1977,

$180,000.00 for 1978, and $125,460.00 for 1979. Vemco

deducted these expenses on its tax returns for 1976

A-16

through 1979, labelling the 1976-1979 amounts as

‘‘development’”’ expenses. Vemco also deducted additional

expenses such as travel, vehicle, rent, etc. in the total

amounts of $25,124.99 for 1976, $20,865.46 for 1977,

$36,308.00 for 1978, and $28,889.00 for 1979. Of those

amounts, $21,346.61 for 1976, $19,024.40 for 1977,

$2,230.00 for 1978, and 1,934.00 for 1979, were included as

part of the total amounts disallowed by respondent.

In his notices of deficiency, respondent set forth the

following alternative grounds upon which he based his

aforementioned determinations. Respondent does not

agree that the amounts were expended for the purposes

designated nor does respondent agree to the characteriza-

tion of the amounts. Respondent also contends that the

amounts claimed as deductions by Vemco represent

amounts paid or incurred in connection with an activity not

engaged in for profit. Alternatively, respondent argues

that the amounts claimed as deductions by Vemco con-

stituted nondeductible capital contributions to either Man-

zanillas or Memco inasmuch as the amounts were paid by

Vemco, their shareholder, on the corporations’ behalf for

corporate expenses.

Inventory Issue

Cannon Aeronautical, Inc. (‘‘Aero’’), of which peti-

tioner was majority owner, was liquidated in 1975, and cer-

tain of its assets (copper wire and airplane parts) were

distributed by Aero, as debtor, to petitioner, as creditor, in

partial satisfaction of a loan. Petitioner then transferred

these assets to Vemco and received a credit to her capital

account of $54,850, which was the book value of the assets

on Aero’s books at the time they were distributed to Vem-

co. The principal asset distributed was 275,000 feet of

20-strand copper wire recorded by Aero at a cost of

A-17

$41,250. It had been purchased by Aero in 1970 and was

obsolete at the time of the transfer to Vemco and had only

scrap value. All of the assets transferred were entered on

Vemco’s books at the cost reflected on Aero’s books. In

1976 Vemco sold certain miscellaneous parts and supplies

for $1,500. In 1976 it wrote down the value on the books of

the remainder of these assets by a total of $42,250, $33,000

of which was attributable to the copper wire. On its returns

for 1976 Vemco claimed cost of goods sold for these assets

in the amount of $42,500, including the $1,500 worth that

were sold. Of the $42,500, cost of goods sold claimed,

$40,750 was attributable to the assets which were not sold

in 1976. Respondent disallowed $40,750 of this claimed

cost of goods sold expense. Respondent also determined

that a $12,600 date of acquisition fair market value should

be allocated to the inventory assets.

OPINION

The parties have stipulated that Vemco paid or in-

curred certain expenses claimed as deductions on its tax

returns for the years in question. The expenses claimed as

deductions by Vemco generally fall into three broad

categories: (1) amounts Vemco contributed directly to the

two Mexican corporations, Manzanillas and Memeo, who,

in turn, allegedly paid out the contributions in connection

with the exploration and development of their respective

mining concessions; (2) amounts Vemco paid directly to

third parties under contract in connection with the explora-

tion and development of the Mexican mining concessions;

and (3) amounts Vemco paid to others for the purchase of

equipment and in the form of salaries, professional fees and

overhead expenses as these amounts relate to the mining

activities of the Mexican corporations.

Petitioner contends that all of the amounts she paid

A-18

out in connection with the mining activities are deductible

under either section 162, 165, 212, 616, or 617. At trial,

respondent reiterated the alternative bases, as set forth in

his notices of deficiency, supra, upon which he determined

the extent to which petitioner's claimed deductions should

be disallowed.

First, the record does not support a finding that

either petitioner or Vemco were directly engaged in the

business of mining gold and silver in Mexico. So none of the

expenses claimed by petitioners are deductible under sec-

tion 162, which requires that they be paid or incurred in

carrying on a trade or business. For the same reason none

of those expenses are deductible by petitioner under sec-

tion 165 as losses. If those expenses are deductible at all

they must be deductible under section 212(1) as ordinary

and necessary expenses paid or incurred for the production

or collection of income, or under section 616 as mining

development expenses or section 617 as mining exploration

expenses.

A basic requirement under all of the above provisions

is a showing that the activity giving rise to the expenditure

was engaged in by petitioner with the objective of making

a profit. Horn v. Commissioner, 90 T.C. 908, 933 (1988);

Patin v Commissioner, 88 T.C. 1086, 1116 (1987). Similarly,

a deduction under section 617 depends upon a showing that

the mining activities constituted a trade or business or

were undertaken and carried on for the production of in-

come. Patin v. Commissioner, supra at 1117, which, in turn,

also depends upon a showing of a bona fide profit objective.

Furthermore, section 183(a) provides the general rule

that if an individual engages in an activity, and “‘if such ac-

tivity is not engaged in for profit, no deduction attributable

to such activity shall be allowed under this chapter except

A-i9

as provided in this section.’ Section 183(b) provides for the

following exceptions to section 183(a) nondeductibility: (1)

Deductions which would be allowable without regard to

whether such activity is engaged in for profit shall be allow-

ed, section 1.183-1(b)(1), Income Tax Regs.; and (2) deduc-

tions which would be allowable only if such activity is

engaged in for profit shall be allowed “but only to the ex-

tent that the gross income derived from such activity for

the taxable year exceeds the deductions allowable by

reason of paragraph (1)."’ Section 183(b\(2). Section 183(c)

defines an activity not engaged in for profit as follows:

FIT DEFINED.—For purposes of this section, the term

“activity not engaged in for profit’’ means any activity

other than one with respect to which deductions are

allowable for the taxable year under section 162 or under

paragraph (1) or (2) of section 212.

Where a partnership is involved, whether an activity

is engaged in for profit is determined at the partnership

level and not at the partner level. Brannen v. Commis-

stoner, 78 T.C. 471, 505 (1982), affd. 722 F.2d 695 (11th Cir.

1984); Siegel v. Commissioner, 78 T.C. 659, 698 (1982). If a

partnership activity is not engaged in for profit by the part-

nership, all partners are denied deductions affected by sec-

tion 183. See Flowers v. Commissioner, 80 T.C. 914, 932

(1983); see also Brannen v. Commissioner, supra at 505.

The determination that an activity is engaged in for

profit is one of fact to be resolved on the basis of all the

facts and circumstances. Flowers v. Commissioner, supra

at 931-932. A reasonable expectation of profit is not re-

quired as long as there is a bona fide objective to realize a

profit. Golanty v. Commissioner, 72 T.C. 411, 425-426

(1979), affd. without published opinion 647 F.2d 170 (9th

Cir. 1981). Profit means economic profit, independent of

A-20

tax savings. Landry v. Commissioner, 86 T.C. 1284, 1303

(1986).

In determining the partnership intent, we have often

focused on the actions taken by the promoters and general

partners, including their intent, knowledge, conduct, exper-

tise, and all other factors they relied upon in making deci-

sions for the partnership. Surloff v. Commissioner, 81 T.C.

210, 233 (1983); Finoli v. Commissioner, 86 T.C. 697, 722

(1986); Brannen v. Commissioner, supra. However, this

does not mean that our inquiry is confined solely to the ac-

tivities of the partnership, ‘‘for those parties possessing

resources sufficient to acquire and exploit investment pro-

perty are not always blessed with corresponding exper-

tise.’ Flowers v. Commissioner, supra at 932. The scope of

the relevant inquiry therefore permeates the entire profit

objective issue must still be assessed from the perspective

of the partnership. Flowers v. Commissioner, supra at 932.

Petitioner bears the burden of proving the required profit

objective. Welch v. Helvering, 290 U.S. 111, 115 (1933);

Rule 142(a).

Section 1.183-2(b), Income Tax Regs., sets forth

several relevant factors which are to be considered in deter-

mining whether an activity is engged in for profit. Among

them are: (1) The manner in which the taxpayer carried on

the activity; (2) the expertise of the taxpayer or his ad-

visors; (3) the time and effort expended by the taxpayer in

carrying on the activity; (4) the expectation that assets us-

ed in the activity may appreciate in value; (5) the success

of the taxpayer in carrying on other similar or dissimilar ac-

tivities; (6) the taxpayer’s history of income or loss with

respect to the activity; (7) the amount of occasional profit,

if any, which is earned; (8) the financial status of tne tax-

payer; and (9) whether elements of personal pleasure or

A-2]

recreation are involved.

Objective facts are accorded greater weight than are

mere statements of intent. Engdahl v. Commissioner, 72

T.C. 659, 666 (1979). No one factor is determinative of the

taxpayer's objective to make a profit. Section 1.183-2(b),

Income Tax Regs. However, a record of substantial losses

over many years and the unlikelihood of achieving a pro-

fitable operation are important factors bearing on the tax-

payer's true objective. Bessenyey v. Commissioner, 45 TC.

261, 274 (1965), affd. 379 F.2d 252 (2d Cir. 1967). As we

stted in Bessenyey v. Commissioner, supra at 274:

the presence of losses in the formative years of a

business, * * * is not inconsistent with an intention to

achieve a later profitable level of operation, bearing in

mind, however, that the goal must be to realize a profit

on the entire operation, which presupposes not only

future net earnings but also sufficient net earning to

recoup the losses which have meanwhile been sustained

in the intervening years.

After a review of the record before us, we are convinc-

ed that Vemco did not enter into the mining activity with

the objective to make a profit. Nor does it appear, for the

reasons stated below, that the mining activity was poten-

tially profitable because it is unlikely that it could ‘recoup

the losses which have meanwhile been sustained in the in-

tervening years.’ Bessenyey v. Commissioner. supra at

274.

Vemco’s decision to enter into the mining activity

was ostensibly based on the $50,172.32 net calculated mon-

thly profit projection contained in Ehrlinger’s report.

These profit projections assumed. inter alia, that an ore

grade of 0.70 troy ounces of gold and 9.0 troy ounces of

silver could be realized per ton of ore mined. However, the

A-22

quality of ore grades used in these profit projections were

inconsistent with the data that was available at the time

the projections were made. The El Paso Chemical

Laboratories report contained the results of the 12 ore

samples. The results of these 12 samples indicated an

average of 0.155 ounce of gold and 2.263 ounces of silver

per ton of ore. Moreover, the results of the six samples con-

tained in Wilcox’s report indicated per ton averages of 0.12

ounces of gold and 2.467 ounces of silver and 0.447 ounces

of gold and 5.64 ounces of silver for Taonita and Tres de

Mayo, respectively. Use of the samples’ highest average

ore grade values in Erhlinger’s profit formula, all other

values remaining constant including the assumed opera-

tiong rate of 50 tons per day, results in a projected cash

flow from the mining operations which falls short of even

achieving/attaining the break-even point, much less a

profit.

The record also contains information concerning the

mining activities for a period of 11 years, 1973-1983.

Neither of the Mexican corporations ever paid a dividend to

Vemco. Vemco reported losses in each and every of the 11

years for a total loss in the amount of $2,205,045.10. A

record of such losses over so many years is persuasive

evidence that Vemco did not possess the requisite objective

of making a profit. Sec. 1.183-2(b)(6), Income Tax Regs.;

Golanty v. Commissioner, supra at 427.

The record also reveals that petitioner received a

substantial annual income from sources unrelated to the

mining activity. Petitioner’s ability to provide Vemco with

continuous capital infusions was no doubt due to her

substantial annual income. But for the existence of peti-

tioner’s substantial annual income, neither petitioner nor

Vemco could have sustained the perennial losses generated

by the mining activity. See section 1.183-2(b)(8), Income

A-23

Tax Regs.

Where a taxpayer procures, but fails to follow, the

advice of experts, a lack of an objective to derive profit may

be indicated unless it appears that the taxpayer is attemp-

ting to develop a different yet profitable technique. Section

1.183-2(b)(2), Income Tax Regs.

In their various reports, Weaver and Ehrlinger

recommended that, in light of several factors including

high transportation costs, a mill be installed at or near the

site of the mine for a profitable and a more efficient opera-

tion overall. In fact, Ehrlinger’s report contained only one

profit projection which was based on an assumed operating

rate of 50 tons per day. Ehrlinger’s report also included

blueprints and estimated costs for a 50 ton capacity mill.

This report, in which profits were forecasted, contained the

only detailed projection of income, expenses and profits

found in the record before us.

Young testified that four tons per day was the max-

imum capacity of the mill that was actually employed in

the mining operations and we find nothing in the record to

indicate that a larger capacity mill was installed. It is ap-

parent that Vemco’s failure to implement Weaver’s and

Ehrlinger’s recommendations for a larger capacity mill,

which was the sole basis upon which we find profits were

projected, severely hampered any chances of transforming

the mining activity into a profitable operation.

Vemco maintained books and records. However, bas-

ed on the record before us, including the testimony of

Carpenter, it is clear that Vemco maintained incomplete

books and records inasmuch as Carpenter was unable to

verify many of Vemco’s claimed payments by tracing them

back to a source document. See section 1.183-2(b)(1),

A-24

Income Tax Regs.

We find it noteworthy that Young’s testimony

revealed that he has never operated a profitable mine.

However, Weaver testified that, in the past, he operated

profitable mines located in Utah and Colorado, but not in

Mexico. See section 1.183-2(b)(5), income Tax Regs.

Weaver aiso testified that he was in charge of the

day-to-day operations at the mining claims from 1973 until

1976 when, although the record is unclear on this point, it

appears that Young became in charge of operations. We are

mindful of the testimony of both Weaver and Young that

they contributed time and effort to the mining operations.

See section 1.183-2(b)(3), Income Tax Regs.

However, we find that, based on the facts shown by

the record in this case, neither Vemco nor petitioner could

have had a bona fide objective or reasonable prospect of

making a profit out of the mining venture. Very little

marketable gold or silver was mined or recovered over 4

period of at least five years (1972-1978), and yet few or no

steps were taken to increase the production. Money may

have been spent to improve the transportation of the ore

from the mine to the market but little was done to bring ore

to the surface for transportation. And very little was spent

to increase or improve the crushing, separation and clean-

ing process had the ore been mined. Under the cir-

cumstances we cannot find that petitioner or Vemco enter-

tained an actual and honest objective of realizing a profit

from the mining activities within the meaning of section

183(a). Based on the record we are at a loss to understand

just what the objective of petitioner and Vemco was in

throwing good money after bad into this project. We har-

bor a suspicion, however, that had petitioner not had a

sizeable outside income and possibly no interest in spend-

op Sa at

A-25

ing her income in any other way, she would have taken a

good hard look at the venture and would have been less

willing to continue putting money into it just to keep it

alive.

We recognize that gold mining is a risky business

and also that if it is successful it will pay off well, and that

some people are willing to take the risk for the anticipated

reward. But where, as here, efforts had been made to mine

this property for years, according to the evidence, without

sufficient production to report any income from mining, it

would be a pipe dream to expect to make a profit without

some change in circumstances, and there is no evidence

that changes were made that would materially increase

production.

On balance we find that neither Vemco nor petitioner

entertained an actual and honest objective of realizing a

profit from this mining venture for the years involved

within the meaning of section 183(a).

Moreover, to the extent that certain deductions

claimed by petitioner, through Vemco, are not precluded by

application of section 183, we nonetheless find that they

are disallowed by virtue of their being the expenses of

another taxpayer.

It is a well-established principle of Federal tax law

that a shareholder is precluded from deducting the ex-

penses of a corporation of which it is a shareholder because

the corporation and its shareholders are recognized as

separate taxable entities. Deputy v. du Pont, 308 U.S. 488

(1940). Although it is true that Vemco’s activities went

beyond the passive holding of stock in the Mexican cor-

poration this, in itself, does not form a sufficient basis upon

which we should disregard the corporate existence of the

A-26

Mexican corporations. Rink v. Commissioner, 51 T.C. 746,

752 (1969). The record before us reveals that the Mexican

corporations had substance, that their existence was not a

mere matter of form, and that they maintained a mean-

ingful corporation/shareholder relationship with Vemco.

Moreover, we have reviewed the character of the expenses

which petitioner, through Vemco, claimed as deductions

and find them to be those properly attributable to the Mex-

ican corporations.

But petitioner contends, for the first time in her re-

ply brief, that the corporate entity should be disregarded

inasmuch as the substance of the relationship between the

Mexican corporations and Vemco was that of a joint ven-

ture. A joint venture is treated and taxable as a partner-

ship for tax purposes under section 761(a) and 7701(a)(2).

See also section 1.761-1(a), Income Tax Regs.

In support of her joint venture contention, petitioner

relies heavily upon Commissioner v. Bollinger, 485 U.S.

340 (1988). Generally, a corporation is regarded as a

separate taxable entity even if it has only one shareholder

who exercises total control over its affairs. Moline Proper-

ties v. Commissioner, 319 U.S. 436 (1943). But where a cor-

poration is acting as the agent of its shareholder, the

separate entities of corporation and shareholder may be

disregarded for Federal tax purposes because the law at-

tributes tax consequences of property held by a genuine

agent to the principal. Commissioner v. Bollinger, supra.

The three-part test to be used in determining whether a cor-

poration is a true agent of its shareholder is (1) whether the

fact that the corporation is acting as an agent with respect

to a particular asset is set forth in a written agreement at

the time the asset is acquired; (2) whether the corporation

functions as agent and not as principal with respect to the

asset for all purposes; and (3) whether the corporation is

A-27

held out as the agent and not as the principal in dealings

with third parties relating to the asset. See George v. Com-

missioner, 844 F.2d 225, 228-229 (5th Cir. 1988), affg. a

Memorandum Opinion of this Court.

After a review of the record before us, we find that

petitioner has failed to satisfy each part of the three-part

Bollinger test. Therefore, Vemco’s relationship vis-a-vis

each of the Mexican corporations was not one of prin-

cipal/agent. Thus, the amounts are not deductible by peti-

tioner, through Vemco, because as a shareholder Vemco is

not entitled to pay and claim a deduction for expenditures

properly attributable to the Mexican corporations. See

Koree v. Commissioner, 40 T.C. 961, 965-966 (1963). In-

stead, we agree with respondeant’s position that petitioner

‘is no doubt entitled [to] additional basis in her allocable

share of the corporate stock attributable to the payment

of’’ amounts that ‘‘*** were related to corporate business

and deductible by the corporation ***”’

In view of the foregoing, we find it unnecessary to

address the remaining issues raised by the parties, save the

inventory issue discussed below, because they are rendered

moot.

Inventory Issue

Whether the application of section 482 reduces Vem-

co’s (and petitioner’s distributive share of) claimed inven-

tory loss to zero for the taxable year 1976.

Section 482 allows respondent to allocate between

any two or more controlled organizations. trades, or

businesses, gross income, deductions, credits, or

allowances if respondent determines that such allocation is

necessary in order to prevent evasion of taxes or clearly to

A-28

reflect the income of any such organizations, trades, or

businesses.

‘“‘Controlled”’ is defined in sweeping terms so as to in-

clude any type of control, direct or indirect, whether legally

enforceable, and however exercisable or exercised. Section

1.482-1(a)(3), Income Tax Regs. It is the reality of the con-

trol which is decisive, not its form or the mode of its

exercise.

Petitioner owned a majority interest in both Cannon

Aero and Vemco. Petitioner exerted financial control over

each organization. Based on the record before us, it is abun-

dantly clear that petitioner controlled both Cannon Aero

and Vemco within the meaning of section 482.

In his notice of deficiency, respondent determined

that a $12,600 date of acquisition fair market vaiue should

be allocated to the inventory assets. Petitioner has the

burden of proving that respondent’s determination is er-

roneous. Welch v. Helvering, supra; Rule 142(a). Therefore,

in order to prevail petitioner must prove that either the

date of acquisition fair market value of the inventory

assets was more than $12,600 to justify a writedown in

1976 or that respondent’s determination under section 482

was unreasonable, arbitrary, or capricious. Ach v. Commis-

sioner, 42 T.C. 114, 126 (1964), affd. 358 F.2d 342 (6th Cir.

1966), cert. denied 385 U.S. 899 (1966).

Petitoner has conceded that the inventory became

obsolete prior to the time petitioner transferred the inven-

tory to Vemco. There is nothing in the record before us in-

dicating that the inventory was worth more than $12,600

at the beginning of the year 1976. The inventory loss was

properly disallowed inasmuch as any allowable loss that

might have been claimed was properly that of Cannon Aero

A-29

and not that of Vemco. Petitioner has clearly failed to carry

her burden of proof, and therefore, respondent’s

disallowance of petitioner’s claimed cost of goods sold in

the amount of $42,250 must be sustained.

Decision will be entered

for the respondent.

A30

Internal Revenue Service Department of the Treasury

Regional Commissioner

Date: 9 FEB 1982 Tax Year Ended and Deficiency:

12-31-76 $136,531.00

12-31-77 $245,576.00

Mrs. Charla Gates Cannon

420 South Marion Parkway, #2002

Denver, Colorado, 80209

Person to Contact

Ronald J. Dombroyski

Certified Mail #367801

Contact Telephone Number

713/226-4604

Dear Mrs. Cannon:

We have determined that there is deficiency (in-

crease) in your income tax as shown above. This letter is a

NOTICE OF DEFICIENCY sent to you as required by

law. The enclosed statement shows how we figured the

deficiency.

If you want to contest this determination in court

before making any payment, you have 90 days from the

above mailing date of this letter (150 days if addressed to

you outside of the United States) to file a petition with the

United States Tax Court for a redetermination of the

amount of your tax. The petition should be filed with the

United States Tax Court, 400 Second Street NW.,

Washington, DC 20217 and the copy of this letter should

be attached to the petition. The time in which you must file

a petition with the Court (90 or 150 days as the case may

be) is fixed by law and the Court cannot consider your case

if your petition is filed late. If this letter is addressed to

A-31

both a husband and wife, and both want to petition the Tax

Court, both must sign the petition or each must file a

separate, signed petition. You can get a copy of the rules

for filing a petition by writing to the Clerk of the United

States Tax Court, at the address shown in this paragraph

If you decide not to file a petition with the Tax Court,

we would appreciate it if you would sign and return the

enclosed waiver form. This will permit us to charge your ac-

count quickly and will limit the accumulation of interest.

The enclosed addressed envelope is for your convenience. If

you decide not to sign and return the waiver and you do not

timely petitiion the Tax Court, the law requires us to bill

you after 90 days from the above mailing date of this letter

(150 days if this letter is addressed to you outside the

United States).

If you have any questions, please contact the person

whose name and telephone number are shown above.

Sincerely yours.

Roscoe L. Egger, Jr.

Commissioner

By /s/_ Vincent A. Imbornone

Vincent A. Imbornone

Associate Chief, Appeals Office

Houston Letter 894(RO)(Rev.8)

Enclosures:

Copy of this letter

Statement

Waiver

Envelope

Room 8031, 515 Rusk Ave., Houston, Texas 77002

A-32

COPY

UNITED STATES TAX COURT

CHARLA GATES CANNON,

Petitioner,

9671-82

COMMISSIONER OF IN-

)

) Docket No.

)

TERNAL REVENUE, )

)

Respondent.

DECISION

Pursuant to the opinion of the Court filed March 20,

1990, and incorporating herein the facts recited in the

respondent's computation as the findings of the Court, it is

ORDERED and DECIDED: That there are deficien-

cies in income taxes due from the petitioner fer the taxable

years 1976 and 1977 in the amounts of $155,221.20 and

$244,581.83, respectively.

(Signed) W.M. DRENNEN

Judge

Entered: JUL 10 1990

A-33

COPY

UNITED STATES TAX COURT

CHARLA GATES CANNON,

Petitioner,

2261-85

COMMISSIONER OF IN-

)

) Docket No.

)

TERNAL REVENUE, )

)

Respondent.

DECISION

Pursuant to the opinion of the Court filed March 20,

1990, and incorporating herein the facts recited in the

respondent's computation as the findings of the Court, it is

ORDERED and DECIDED: That there are deficien-

cies in income taxes due from the petitioner for the taxable

years 1978 and 1979 in the amounts of $120,334.60 and

$101,980.00, respectively.

(Signed) W.M. DRENNEN

Judge

Entered: JUL 10 1990

A-34

APPENDIX D

PUBLISH

UNITED STATES COURT OF APPEALS

TENTH CIRCUIT

FILED

NOV 15 1991

CHARLA GATES CANNON,

Petitioner-Appellant,

Docket No.

90-9017

Vv.

)

COMMISSIONER OF IN-

TERNAL REVENUE, )

)

Respondent-Appellee.

Appeal from the United States Tax Court

No. 9671-82

Towner Leeper of Leeper & Leeper, E] Paso, Texas (Arthur

Bosworth of Denver, Colorado with him on the brief) for

Petitioner-Appellant.

Sally J. Schornstheimer of the United States Department

of Justice, Tax Division, Washington, D.C. (Gary R. Allen,

a ii i iia a alls ta

A-35

Richard Farber, and Shirley D. Peterson with her on the

brief) for Respondent-Appellee.

Before MOORE and EBEL, Circuit J udges, and ANDER-

SON, District Judge*.

EBEL, Circuit Judge.

This case concerns a taxpayer who became involved

in an unprofitable mining venture and deducted her

distributive share of certain partnership losses on her in-

come tax returns. The Commissioner of Internal Revenue

disallowed these deductions, and the Tax Court upheld the

Commissioner’s determinations. The taxpayer appeals,

raising two issues. First, did the Tax Court correctly

resolve the case on a theory not considered by either party,

namely, section 183 losses? Second, did the Tax Court cor-

rectly conclude that the limited partnership did not incur

the expenses at issue with the requisite profit motive? We

conclude that the Tax Court’s reliance on section 183 was

proper and that the court’s findings regarding partnership

motives were not clearly erroneous. Accordingly, we

affirm.

I. BACKGROUND

The facts in this case are fully set forth in the Tax

Court's opinion. See Cannon v. Commissioner, 59 T.C.M.

(CCH) 164 (1990). For purposes of this appeal, they may be

summarized as follows:

* The Honorable Aldon J. Anderson, District Judge, United States

District Court for the District of Utah, sitting by designation.

A-36

This case involves a taxpayer's treatment of losses

incurred in connection with a Mexican gold and silver min-

ing venture. In 1973, the taxpayer, Charla Cannon, joined

a limited partnership (‘‘Vemco”’) that was formed ‘‘to

engage in the business of land development, exploration,

mining and ore processing both in the United States and

foreign countries.”’ Jd. at 165 (citation omitted). The tax-

payer, who had a large annual income from trusts and her

deceased husband’s estate and employment benefits, pro-

vided Vemco with the funds necessary to conduct its

business operations. In return, she was to receive a higher

percentage than her partners of the profits or the proceeds

in the event of a sale or disposition of the partnership

assets. In addition, the annual expenses and losses of the

partnership were allocated to the taxpayer insofar as her

capital account permitted.

Vemco decided to invest in the Mexican venture at

issue in this case in reliance upon the findings of an ex-

perienced miner who explored the sites and an engineer

who analyzed-and reported on the mining properties.

Because Mexican law prohibits non-Mexican nationals or

corporations from acquiring a majority interest in Mexican

mining concessions, Compania Minera San Jose de Man-

zanillas, S.A. (‘‘Manzanillas’’), a Mexican corporation, held

the mining concessions, and Vemco became a forty-nine

percent shareholder in that corporation.! In 1978,

however, Vemco discovered that the president of Man-

zanillas had been embezzling, and the mining concessions

were transferred to Memco, a different Mexican corpora-

tion. Although the taxpayer, through Vemco, expended

over $800,000 for exploration and development of the

mines, Memco never operated at a profit. Vemco did not

1 The taxpayer claimed that Vemco was in a joint venture with this

Mexican corporation, but the Tax Court rejected this argument. 59

T.C.M. at 171.

A-37

report any income from mining for the years involved in

this lawsuit, nor did it receive any dividends.

The taxpayer deducted her distributiv_ share of the

partnership losses claimed by Vemco on her federal income

tax returns for 1976, 1977, 1978, and 1979. The Commis-

sioner of internal Revenue (‘‘Commissioner’’) disallowed

these deductions on the grounds that the taxpayer did not

establish that these amounts constituted ordinary and

necessary business expenses or were for an activity entered

into for profit or for the production of income. Alternative-

ly, the Commissioner asserted that these amounts were

nondeductible capital contributions to the Mexican cor-

poration that the parties formed to hold title to the mines.

The Tax Court agreed with the Commissioner's deci-

sion to disallow the deductions, but found the expenditures

to be nondeductible under section 183 of the Internal

Revenue Code. Because the Tax Court decided the case on

the basis of a section that neither party raised explicitly,

the taxpayer filed a motion for reconsideration, which was

denied. The taxpayer appeals. This court has jurisdiction

to review the Tax Court’s decision pursuant to 26 U.S.C. §

7482(a).

We first discuss whether the Tax Court erred in

resolving this case on the basis of section 183. We then

discuss whether the expenses at issue were incurred with

the requisite profit motive.

II. DISCUSSION

A. The Propriety of Resolving the Case Under Sec-

tion 183

In Commissioner v. Transport Manufacturing &

A-38

Equipment Co., 478 F.2d 731, 735 (8th Cir. 1973), the

Eighth Circuit stated that the Commissioner should notify

the taxpayer of the particular Code section, regulation, or

theory involved in a case to avoid prejudice to the tax-

payer. The court reasoned that “‘[t]he taxpayer works at an

extreme disadvantage in trying to invalidate deficiency

assessments if he does not specifically know why the Com-

missioner is challenging the taxpayer.’’ Id. (footnote omit-

ted). The court recognized, however, that prejudice does

not always result: “Of course, if a certain Code section,

regulation or theory has not been specifically raised in the

notice of deficiency, in the pleadings, or at trial and if there

is an absence of surprise on the taxpayer’s part, the tax-

payer has no reason to complain.”’ Jd. n.8 (citation omitted).

Here, the taxpayer contends that the Tax Court er-

roneously decided this case on the basis of a theory and

Code provision (lack of profit motive and section 183) that

neither party considered or raised, thereby surprising and

prejudicing the taxpayer. According to the taxpayer, only

three Code sections were at issue: sections 162, 212, and

616.2 We disagree. Section 183 is interrelated to sections

162 and 212, profit motive being the common underlying

theme. Indeed, as discussed infra, these provisions even

reference each other. Accordingly, we find that the tax-

2 Section 162 allows for the deduction of “‘all the ordinary and necessary

expenses paid or incurred during the taxable year in carrying on any

trade or business .. . .”’ I.R.C. § 162(a).

Section 212 allows for the deduction of ‘all the ordinary and

necessary expenses paid or incurred during the taxable year — (1) for the

production or collection of income; [or] (2) for the management, conserva-

tion, or maintenance of property held for the production of income. . .

” LR.C, § 212.

Section 616 allows for the deduction of development expenditures

for mines and other naturai deposits ‘if paid or incurred after the ex-

istence of ores or minerals in commercially marketable quantities has

been disclosed.” I.R.C. § 616(a).

A-39

payer in this case was adequately put on notice, was not

prejudiced, and should not have been surprised.

The taxpayer asserts that neither party ever con-

sidered the Tax Court’s position that a profit motive was

not present. Yet, the evidence reveals that profit motive

was indeed a critical issue in this case and that the Com-

missioner was unwilling to concede the presence of a profit

motive. For example, the statutory notices of deficiency

that the Commissioner issued to the Taxpayer expressly

stated that she had not established that she entered into

the transaction in pursuit of economic profit and that this

lack of profit motive was one of the bases for the

disallowance of the claimed partnership deductions.

Record, vol. I, doc. 3, Deficiency Notice, Explanation of

Adjustments, Exhibit A. In addition, the Commissioner’s

opening statement explicitly noted that the taxpayer had

to prove a profit motive. Record, vol. II, Transcript, Nov.

19, 1986, at 26. Indeed, the taxpayer attempted to do this,

see infra Part II.B, and acknowledged that “‘[t]o obtain a

deduction under Section 162 for a trade or business ex-

pense or under Section 212 for an expenditure for the pro-

duction of income requires a profit motive.’’ Brief for Ap-

pellant at 37.3

In determining whether the mining activity met the

requirements of sections 162 or 212, the court naturally ap-

plied section 183. Section 183 is often used in analyzing

‘for profit’’ issues, both in the context of hobby losses and

in the context of trade or business expenses. Numerous

courts have used the regulations accompanying section 183

to determine profit motive under other sections. See, e.g.,

independent Elec. Supply, Inc. v. Commissioner, 781 F.2d

3 Thomas v. Commissioner, 792 F.2d 1256, 1259 (4th Cir. 1986),

establishes that section 616 also requires a profit motive.

A-40

724, 726-27 (9th Cir. 1986) (‘‘the courts have relied on the

section 183 factors in conducting the profit motive analysis

under section 162’’); Brannen v. Commissioner, 722 F.2d

695, 704-06 (11th Cir. 1984) (applying factors listed in sec-

tion 183 regulations to determine whether taxpayer’s ac-

tivities were engaged in for profit under section 162);

Faulconer v. Commissioner, 748 F.2d 890, 893 (4th Cir.

1984) (referring to section 183 to determine whether a tax-

payer was entitled to deductions under sections 162 or 212,

noting that the profit motive is the same under all three

statutory sections, and concluding that ‘‘[t]he regulations

under section 183, therefore, explicate the profit-motive re-

quirements of sections 162 and 212’’); Carter v. Commis-

sioner, 645 F.2d 784, 786 (9th Cir. 1981) (‘‘[section] 183(c)

must be reed in conjnunction with [section] 162’’) (footnote

omitted); Dreicer v. Commissioner, 665 F.2d 1292, 1294

(D.C. Cir. 1981) (‘a taxpayer claiming a deduction under

Sections 162 or 212 for an expense, or under Section 165 for

a loss, must be prepared to demonstrate an associated pro-

fit motive in order to avoid the ban of Section 183’’) (foot-

note omitted). Thus, the Tax Court’s application of section

183 was routine and predictable, not extraordinary.

In fact, the regulations accompanying section 212,

on which the taxpayer relied, expressly refer to section 183.

They specify that the inquiry as to profit motive under sec-

tion 212 is determined by reference to section 183 and the

accompanying regulations: ‘‘For provisions relating to ac-

tivities not engaged in for profit applicable to taxable years

beginning after December 31, 1969, see section 183 and the

regulations thereunder.’’ Treas. Reg. § 1.212-1(c). Section

183 similarly references sections 162 and 212 when it

defines ‘‘activity not engaged in for profit’’ as ‘‘any activi-

ty other than one with respect to which deductions are

allowable . . . under section 162 or under paragraph (1) or

A-41

(2) of section 212.’’ I.R.C. § 183(c).

In summary, the tax Court did not err in resolving

this case on the basis of Internal Revenue Code section 183.

Given the importance of profit motive, the Tax court’s

reliance on section 183 was both predictable and

nonprejudicial.

B. Applying Section 183

Having determined that it was proper to utilize sec-

tion 183 in this case, we next address whether the Tax

Court correctly applied the factors enumerated in the

Treasury Regulations accompanying that section.

Whether Vemco and the taxpayer were in pursuit of

economic profit is a question of fact. The applicable stand-

ard of review is a stringent one: a finding of fact should not

be disturbed unless it is clearly erroneous. Fed. R. Civ. P.

§2(a). “‘A finding is ‘clearly erroneous’ when although there

is evidence to support it, the reviewing court on the entire

evidence is left with a definite and firm conviction that a

mistake has been committed.’’ United States v. United

States Gypsum Co., 333 U.S. 364, 395 (1948).

The taxpayer makes a persuasive argument that

might well have convinced us if we were examining the

record de novo. However, as the Supreme Court stated in

Anderson v. Bessemer City, 470 U.S. 564 (1985):

This [clearly erroneous] standard plaintly does not en-

title a reviewing court to reverse the finding of the

trier of fact simply because it is convinced that it

would have decided the case differently. . . . If the

district court’s account of the evidence is plausible in

light of the record viewed in its entirety, the court of

appeals may not reverse it even though convinced that

A-42

had it been sitting as the trier of fact, it would have

weighed the evidence differently.

Id. at 573-74. Given the Tax Court’s ‘“‘plausible’’ account of

the evidence, we cannot say as a reviewing court that its

decision was clearly erroneous. After a thorough examina-

tion of the facts and circumstances of this case, we

therefore affirm the Tax Court’s determination that neither

the taxpayer nor Vemco possessed the requisite profit

motive.

The Tax Court appropriately delineated the proper

procedures to follow in determining whether an activity is

engaged in for profit. Where a partnership is involved, as

it is in this case, the dominant economic motive of the part-

nership, not that of the individual investors, is deter-

minative. Polakof v. Commissioner, 820 F.2d 321, 323 (9th

Cir. 1987), cert. denied, 484 U.S. 1025 (1988); Tallal v. Com-

missioner, 778 F.2d 275, 276 (5th Cir. 1985); Brannen, 722

F.2d at 703-04.

The taxpayer bears the burden of proving the re-

quired profit objective. Tax Ct. R. 142(a); Welch v. Helver-

ing, 290 U.S. 111, 115 (1933). The test is whether profit was

the dominant or primary objective of the venture. See, e.g.,

Polakof, 820 F.2d at 323-24 (‘dominant economic motive.”’

“primary purpose’’); Thomas v. Commissioner, 792 F.2d

1256, 1259 (4th Cir. 1986) (‘‘primary objective’’); Snyder v.

United States, 674 F.2d 1359, 1364 (10th Cir. 1982)

(“primarily motivated’’); Eastman v. United States, 635

F.2d 833, 837 (Ct. Cl. 1980) (‘primary purpose, ”’ “‘over-

riding profit motivation’’).

The regulations under section 183 set forth nine

nonexclusive factors to be considered in determining

whether a taxpayer’s activities are engaged in with the ob-

A-43

jective of realizing a profit: (1) the extent to which the tax-

payer carries on the activity in a businesslike manner; (2)

the taxpayer’s expertise or his reliance on the advice of ex-

perts; (3) the time and effort the taxpayer expends in carry-

ing on the activity; (4) the expectation that assets used in

the activity may appreciate in value; (5) the taxpayer’s suc-

cess in similar activities; (6) the taxpayer’s history of in-

come or loss in the activity; (7) the amount of occasional

profits, if any; (8) the taxpayer’s financial status; and (9)

the elements of personal pleasure or recreation. Treas. Reg.

§ 1.183-2(b).

The Treasury Regulations provide insight regarding

how to apply these objective factors to determine subjec-

tive intent. The ultimate inquiry entails examining the

facts and circumstances of each case:

No one factor is determinative in making this deter-

mination. In Addition, it is not intended that only the

factors described in this paragraph are to be taken in-

to account in making the determination, or that a

.-. determination is to be made on the basis that the

~~ number of factors (whether or not listed in this

paragraph) indicating a lack of profit objective ex-

ceeds the number of factors indicating a profit objec-

tive, or vice versa.

Id.

The Tax Court applied the relevant factors and con-

cluded that the partnership was not motivated by profit on

the following bases: (1) the $50,172.32 projected net month-

ly profit that lured the taxpayer and Vemco into this min-

ing activity, predicted in the expert’s report, was un-

attainable as it was erroneously based upon projected ore

grades that were contrary to actual test results. (2) Vemco

failed to increase the milling capacity of the mines as

A-44

recommended in the same expert report.4 (3) Vemco con-

tinued to fund projects relating to the mines even though

they had an unbroken record of substantial losses

($2,205,045.10), they were unlikely to recoup those losses,

and the Mexican corporations never paid a dividend to

Vemco. (4) Despite these losses, Vemco took few steps to

increase production. (5) The taxpayer received substantial

income from other sources, which enabled her to provide

large amounts of capital.° (6) Vemco maintained in-

complete books and records.

In support of the taxpayer’s position, the Tax Court

acknowledged that some of the limited partners con-

tributed time and effort to the mining operations® and that

one limited partner had operated profitable mines in the

past.’ We add several other factors to this short list, name-

ly the taxpayer’s repeated statements regarding profit

motive during the proceedings below, the taxpayer's

reliance upon expert advice, and the lack of an alternative

non-profit-making explanation for the venture.

The taxpayer stated during the proceedings before

4 Treas. Reg. § 1.183-2(b)(2) provides: ‘Where a taxpayer . . . procures

... expert advice, but does not carry on the activity in accordance with

such practices, a lack of intent to derive profit may be indicated unless

it appears that the taxpayer is attempting to develop new or superior

techniques which may result in profits from the activity.”’

° Although we agree with the Tax Court's assessment of the other

Treasury Regulation factors, we find the factor focusing upon the finan-

cial status of the taxpayer to be a wash. See Treas. Reg. § 1.183-2(b)(8).

6 See Treas. Reg. § 1.183-2(b)(3).

7 See Treas. Reg. § 1.183-2(b\(5). The taxpayer's own previous

businesses included a profitable aeronautical business, an unprofitable

sheep-raising operation, a profitable woman’s exercise and health spa,

and a helicopter sales business for which success or lack of success was

not established. Record, vol. II, Transcript, Nov. 20, 1986, at 297-300.

oe ee,

si Sle get ela ia ae! *

A-45

the Tax Court that she was indeed motivated by a desire

to profit:

Counsel: What was your motive in — why did you

want to spend — make an investment down

there? do you enjoy mining?

Cannon: Well, I had heard a great deal about mining

all my life, but also, over and above that, I

obviously was down there to make money.

I have invested in several things throughout

my lifetime and this one looked very good .

I had no intention to do anything except

make money.

Record, vol. II, Transcript, Nov. 20, 1986, at 289-90. She

also discussed the profitability of her former ventures and

the anticipated profits of this venture. Jd. at 285, 293,

296-300.8

Vemco’s solicitation of expert advice further sup-

ports the taxpayer’s contention that the mining activity

was engaged in for profit. See Treas. Reg. § 1.183-2(b)(2).

Carl Weaver, an experienced miner since 1939 in Arizona,

Colorado, Utah, and Mexico and a limited partner in Vem-

co, explored the mines and prepared a report on their

histories and capabilities. Henry Ehrlinger, a professor of

mining and engineering at the university of Texas at El

Paso, also analyzed and reported on the mines. Ehrlinger

8 We note, however, that a taxpayer's statement of intent is given less

weight than objective factors in determining such intent. Treas. Reg. §

1.183-2(a); Engdahi v. Commissioner, 72 T.C. 659, 666 (1979); see also

Brodrick v. Derby, 236 F.2d 35, 38 (10th Cir. 1956) (circumstances may

indicate motive contrary to that stated).

A-46

had considerable experience in Mexican mining and had

operated a company similar to Vemco on his own. Ralph

Wilcox, Jr., a graduate geology student at the University

of Texas, analyzed ore samples taken from the mines. The

taxpayer relied upon this expertise. Record, vol. 2,

Transcript, Nov. 20, 1986, at 283-89.

Finally, the ninth factor, ‘‘Elements of personal

pleasure or recreation,’’ deserves more attention than it

was given by the Tax Court. Treas. Reg. § 1.183-2(b)(9)

clearly indicates that ‘‘a profit motivation may be in-

dicated where an activity lacks any appeal other than pro-

fit.’” Here, the absence of any suggestion of an alternative

motive in the record is a powerful factor in support of the

taxpayer’s position.?

Although it is unclear what besides profit might

have prompted Vemco to expend substantial amounts of

money on this venture, we cannot declare the court’s fin-

ding clearly erroneous. The Tax Court carefully applied the

appropriate factors and provided a solid basis for its

decision.

With respect to the experts’ reports, the Tax Court

9 Courts that fail to discern a profit motive often specify an alternative

explanation for a party's actions. See, e.g., Polakof, 820 F.2d at 324

(limited partnership that bought film properties was motivated by a

desire to create tax shelters rather than to profit); Thomas, 792 F.2d at

1258 (primary objective of coal mining program was to secure tax

benefits rather than to earn an economic profit); Estate of Power v. Com-

missioner, 736 F.2d 826, 831 (1st Cir. 1984) (taxpayer's horse-breeding

activity was engaged in for personal satisfaction, not profit); Eastman,

635 F.2d at 841 (family engaged in horse-breeding in order to utilize the

losses from that operation to offset other income). But see Antonides v.

Commissioner, 893 F.2d 656, 660 (4th Cir. 1990) (suggesting that the

court does not need to pinpoint the likely motivation, as long as it deter-

mines on the basis of the Treasury Regulation factors that the activity

was not engaged in for profit).

el bMS df

Data BG ite OOP Oe PD ad

A-47

emphasized that Ehrlinger’s monthly profit projection of

$50,172.32 was erroneously based upon inconsistent data

regarding the ore grades that could be realized per ton of

- ore mined. 59 T.C.M. at 169. The actual assay work on the

ore veins showed a decidedly poorer ore body in general

than was assumed in the expert’s report. Jd. In addition,

Vemco did not implement the critical aspects of the ex-

perts’ advice, upon which any prospect of profits depended.

Id. at 170. See Treas. Reg. § 1.183-2(b)(2) (where a taxpayer

procures but does not follow expert advice, ‘‘a lack of intent

to derive profit may be indicated’’). Specifically, Weaver

and Ehrlinger recommended that Vemco install a higher

capacity mill in order to enhance the efficiency and pro-

fitability of the mines; indeed, their profit projections

depended upon this mill. Vemco never installed it, however,

thereby preclusing any chances of transforming this min-

ing venture into a profitable operation. 59 T.C.M. at 170.

The Tax Court also emphasized that Vemco did not

receive any profits from this mining venture for an entire

eleven-year-period. In fact, the mines had an unbroken

record of substantial losses totalling $2,205,045.10. Id. at

169. A record of such persistent and substantial losses is

persuasive evidence that Vemco did not possess the re-

quisite profit motive. See Treas. Reg. § 1.183-2(b)(6)

(‘‘[W]here losses continue to be sustained beyond the period

which customarily is necessary to bring the operation to

profitable status such continued losses, if not explainable,

... May be indicative that the activity is not being engaged

in for profit.’’). Furthermore, Vemco took few steps to in-

crease production in the face of these overwhelming losses,

and the record reveals that Vemco was unlikely to recoup

the losses.

Finally, Vemco maintained incomplete books and

records, as it was unable to verify many claimed

A-48

payments by tracing them back to a source document. See

Treas. Reg. § 1.183-(2)(b)(1).

In summary, the record reveals that several of the

factors set forth in Treas. Reg. § 1.183-2(b) support the tax-

payer's position, whereas others support the government’s

position. Taking all facts and circumstances into account,

we cannot say that the Tax Court’s application of the

Treasury Regulations accompanying section 183 was clear-

ly erroneous. Accordingly, we AFFIRM the findings of the

Tax Court.

In light of this ruling, we need not address the alter-

native basis that the Tax Court provided for its decision,

namely that the deductions that the petitioner claimed

through Vemco “‘are disallowed by virtue of their being the

expenses of another taxpayer.’’ 59 T.C.M. at 170.

AFFIRMED.

A-49

APPENDIX E

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

CHARLA GATES CANNON,

Petitioner - Appellant,

COMMISSIONER OF IN-

)

Vv. ) No.90-9017

)

TERNAL REVENUE, )

)

Respondent - Appellee.

ORDER

Filed January 13, 1992

Before MOORE and EBEL, Circuit Judges, and ANDER-

SON, District Judge.*

This matter comes on for consideration of petitioner-

appellant’s petition for rehearing filed December 16, 1991.

* Honorable Aldon J. Anderson, District J udge, United States District

Court for the District of Utah, sitting by designation.

A-50

Upon consideration thereof, the petition is denied.

Entered for the Court

Robert L. Hoecker, Clerk

By /s/_Partrick Fisher —

Patrick Fisher

Chief Deputy Cierk

A-51

APPENDIX F

Senate Report 91-552

exchange tax-free property of a like-kind.

General reasons for change.—One aspect of the farm

loss problem called to the committee’s attention does not

involve a practice permitted by present law, but rather in-

volves an erroneous interpretation of the like-kind ex-

change rule of present law. It appears this rule has been in-

correctly represented by some persons who promote tax-

motivated livestock purchases. There appear to have been

representations that male calves can be traded for female

calves tax free as a like-kind exchange. The importance of

this arises from the fact that ordinarily the ratio of males

to females in a calf crop is approximately 50-50. Since few

males are normally retained in a typical cattle operation,

the remaining male calves are castrated and sold as steers

at ordinary income rates. If a tax-free trade of male calves

for female calves were allowed, a breeding herd of females

could be built up more quickly without tax consequences.

The committee understands that the Revenue Ser-

vice does not consider this to be a like-kind exchange

(although it has no published position). The House Ways

and Means Committee in its report on this bill noted this

problem and indicated it believed that Congress did not in-

tend this type of exchange to be considered as a like-kind

exchange. It also stated its belief that allowing this treat-

ment would be an incorrect interpretation of the statute.

The committee agrees with the House that this type

of exchange should not be considered a like-kind Exchange.

When male calves are exchanged for female calves, the ex-

change does not involve like-kind property since the male

animals are not held for breeding purposes and, in fact, are

A-52

not of a “‘like-kind’’ with females. The committee believes,

however, that it would be more appropriate to specifically

deal with this matter in the bill.

Explanation of provision.—For the above reasons,

the committee amendments provide that, for purposes of

applying the tax-free, like-kind exchange rule of present

law, livestock of different sexes are not property of a like-

kind.

Effective date.—Since this provision is merely

declaratory of what Congress intended in present law, it is

to apply with respect to taxable years to which the Internal

Revenue Code of :954 applies.

5. Hobby Losses (sec. 213 of the bill and secs. 183 and

270 of the code)

Present law.— Present law contains a so-called ‘‘hob-

by loss’’ provision (section 270) which limits to $50,000 per

year the amount of losses from a trade or business carried

on by an individual that can be used to offset other income.

This limitation only applies, however, where the losses

from the business exceed $50,000 per year for a period of

at least 5 consecutive years. In computing the amount of

a loss for purposes of this provision, certain specially

treated deductions are disregarded. These deductions are

taxes, interest, casualty, and abandonment losses con-

nected with a trade or business, farm drought losses, net

operating loss carryovers, and expenditures which may

either be capitalized or currently deducted.

[103] General reasons for change.—The hobby loss provi-

sion generally has been of very limited application. It is

often possible for a taxpayer to slightly rearrange his in-

come and deductions so as to break the required string of

wha anid e

A-53

5 years. In addition, the exclusion of certain specially

treated deductions from the loss computations means that

a number of expenses are not considered to give rise to a

loss even though they are in fact deducted. Moreover, in

the few cases in which the hobby loss provision has applied

so as to disallow the deduction of the loss, the taxpayer has

been faced in 1 year with a combined additional tax at-

tributable to a 5-year period.

In addition to the hobby loss provision, some court

cases have provided another basis on which the loss can be

denied; namely, that the activity carried on by the tax-

payer from which the loss results is not a business but is

merely a hobbv. The committee agrees with the House that

this basic principle provides a more effective and

reasonable basis for distinguishing situations where tax-

payers are not carrying on a business to realize a profit, but

rather are merely attempting to utilize the losses from the

operation to offset their other income.

The House bill replaced the present hoppy loss provi-

sion with a rule which provided that a taxpayer (individual

or corporate) could not deduct losses arising from an activi-

ty carried on by him if the activity was carried on without

a reasonable expectation of realizing a profit from it. Where

the losses from an activity were more than $25,000 in three

out of five consecutive years, then the activity would have

been presumed to have been carried on without the re-

quisite expectation of profit unless it was shown to the con-

trary by the taxpayer.

As previously indicated, the committee is in basic

agreement with the approach taken by the House to the

hobby loss problem. The committee is concerned, however,

that requiring a taxpayer to have a “reasonable expecta-

tion’’ of profit may cause losses to be disallowed in situa-

A-54

tions where an activity is being carried on as a business

rather than as a hobby. Accordingly, the committee has

modied the House bill to provide that in determining

whether losses from an activity are to be allowed, the focus

is to be on whether the activity is engaged in for profit

rather than whether it is carried on with a reasonable ex-

pectation of profit. This will prevent the rule from being ap-

plicable to situations where many would consider that it is

not reasonable to expect an activity to result in a profit

even though the evidence available indicates that the ac-

tivity actually is engaged in for profit. For example, it

might be argued that these was not a ‘“‘reasonable’’ expec-

tation of profit in the case of a bona fide inventor or a per-

son who invests in a wildacat oil well. A similar argument

might be made in a case of a poor person engaged in what

appears to be an inefficient farming operation. The commit-

tee does not believe that this provision should apply to

these situations or that the House intended it to do so app-

ly, if the activity actually is engaged in for profit.

Concern also has been expressed as to whether there

would be a reasonable administration of this new provision.

In view of this, the committee believes that the Treasury

Department should establish two advisory groups down

from the cattle and horse industries (one concerned with

the cattle industry and one with the horse industry) to

assist the Commissioner of Internal Revenue in

establishing standards for the application of these rules to

achieve reasonable results and to resolve policy questions

in their application from time to time. This action should

help limit the disallowance by the Internal Revenue [104].

Service of the deduction of losses under this provision to

cases where it is generally recognized that this is ap-

propriate. The Treasury Department has indicated its will-

ingness to establish advisory groups of this nature.

a eet be ls WII gts As

A-55

Explanation of provision.—The committee amend-

ments provide in general that an individual (or a sub-

chapter S corporation) is not to be allowed to deduct losses

(to the extent attributable to business deductions) arising

from an activity which is not engaged in for profit. The

committee amendments do not apply to corporate tax-

payers (other than shareholders of subchapter S corpora-

tions), as did the House bill, since it is primarily in the case

of individual taxpayers that the problem arises of a tax-

payer entering into an activity to obtain a loss from the ac-

tivity which is used to offset other income. In addition, the

application of the provision to corporations would present

a number of difficulties, such as its effect on shared

facilities provided on a cost basis. No inference should be

drawn from this action in the case of a corporation,

however, as to whether or not any activity of the corpora-

tion is a business, or is engaged in for profit, for purposes

of the tax laws.

The committee amendments provide that an activity

is not engaged in for profit if deductions with respect to the

activity not allowable as trade or business expenses or as

expenses incurred for the production of income or in con-

nection with property held for the production of income. In

making the determination of whether an activity is not

engaged in for profit, the committee intends that an objec-

tive rather than a subjective approach is to be employed.

Thus, although a reasonable expectation of profit is not to

be required, the facts and circumstances (without regard to

the taxpayer’s subjective intent) would have to indicate

that the taxpayer entered the activity, or continued the ac-

tivity, with the objective of making a profit. As previously

indicated, a taxpayer who engaged in an activity in which

there was a small chance of a large profit, such as a person

who invested in a wildcat oil well or an inventor could

qualify under this test even though the expectation of pro-

A-56

fit might be considered unreasonable.

Where an activity is not engaged in for profit, this

provision specifically provides that a deduction is to be

allowed for items which may be deducted without regard to

whether they are incurred in a trade or business or for the

production of income. This would include the deductions

allowed for interest and state and local property taxes, and

the long’term capital gains deduction. It is further provid-

ed that, in the case of an activity not engaged in for profit.

a deduction is nevertheless to be allowed for the trade or

business or production in income items which could be

deducted if the activity were engaged in for profit, but only

to the extent these items do not exceed the amount off

gross income derived from the activity reduced by the

deductions which are allowed in any event such as interest

and certain state and local taxes. The deductions of this

type which are to be allowed first (but after taxes, etc.) are

those such as_ depreciation which involve basis

adjustments.

Under the committee amendments a taxpayer is to

be presumed to be engaged in an activity for profit for a

taxable year, unless established to the contrary by the

Secretary of the Treasury or his delegate, if in two or more

years of the period of five consecutive taxable years ending

with the current taxable year, the activity was carried on

at a profit (i.e., if the gross income from the activity ex-

ceeds the deductions [105] attributable to the activity

which would be allowed if it were engaged in for profit). For

purposes of this presumption, ail deductions attributable

to the activity other than that allowed for net operating

loss carryovers are to be taken into account.

Effective date.—This provision generally is to be ef-

fective with respect to taxable years beginning after

A-57

December 31, 1969. For purposes of applying the presump-

tion, however, this provision also is to be applicable to prior

taxable years.

6. Gain From Disposition of Farm Land (sec. 214 of the bill

and sec. 1251 of the code)

Present Law.—Present law allows a taxpayer engaged in

the farming

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.