1997 Tax Ct. Memo LEXIS 453 | Tax Ct. | 1997
1997 Tax Ct. Memo LEXIS 453">*453 Decision will be entered under Rule 155.
MEMORANDUM OPINION
SWIFT,
Docket Nos. 37087-86 and 8910-88 | |||||||
John C. and Cornelia Vanderschraaf | |||||||
Increased Interest and Additions to Tax | |||||||
Sec. | Sec. | Sec. | Sec. | Sec. | Sec. | ||
Year | Deficiency | 6621(c) | 6653(a) | 6653(a)(1) | 6653(a)(2) | 6659 | 6661 |
1980 | $ 23,084 | * | $ 1,154 | -- | -- | -- | -- |
1981 | 21,939 | * | -- | $ 1,097 | ** | $ 6,582 | -- |
1982 | 12,184 | * | -- | 609 | ** | 3,655 | *** |
* 120 percent of interest accruing after Dec. 31, 1984, | |||||||
on portion of the underpayment attributable to a tax- | |||||||
motivated transaction. | |||||||
** 50 percent of interest due on portion of underpayment | |||||||
attributable to negligence. | |||||||
*** 25 percent of underpayment due on portion attributable | |||||||
to substantial understatement of tax. |
Docket No. 6079-88 | ||||||
Estate of Donald R. Lawrenz, Sr., Deceased, and Ella A. Lawrenz | ||||||
Increased Interest and Additions to Tax | ||||||
Sec. | Sec. | Sec. | Sec. | Sec. | ||
Year | Deficiency | 6621(c) | 6653(a) | 6653(a)(1) | 6653(a)(2) | 6659 |
1980 | $ 137,835 | * | $ 6,892 | -- | -- | -- |
1981 | 200,227 | * | -- | $ 10,011 | ** | $ 60,068 |
* 120 percent of interest accruing after Dec. 31, 1984, | ||||||
on portion of the underpayment attributable to a tax- | ||||||
motivated transaction. | ||||||
** 50 percent of interest due on portion of underpayment | ||||||
attributable to negligence. |
Docket No. 21729-88 | |||
Estate of Donald R. Lawrenz, Sr., Deceased | |||
Increased Interest and Addition to Tax | |||
Sec. | Sec. | ||
Year | Deficiency | 6621(c) | 6653(a) |
1979 | $ 212,325 | * | $ 10,616 |
* 120 percent of interest accruing after Dec. 31, 1984, | |||
on portion of the underpayment attributable to a tax- | |||
motivated transaction. |
Unless otherwise indicated, all section references are to the Internal Revenue Code, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After settlement of some issues, the primary issue for decision is whether the profit objective of certain partnership investments1997 Tax Ct. Memo LEXIS 453">*455 should be measured at the partnership level or at the individual partner level.
Many of the facts have been stipulated and are so found. The entire trial record and the testimony and exhibits admitted into evidence in our test case opinion in
Background and other general facts as they were found in
Petitioners, John C. and Cornelia Vanderschraaf, resided in Fountain Valley, California, at the time they filed their petitions.
Petitioners, Donald R. and Ella A. Lawrenz, resided in Corona Del Mar, California, at the time they filed their petitions.
On their respective Federal income tax returns for the years in issue, petitioners1997 Tax Ct. Memo LEXIS 453">*457 claimed large losses and interest deductions relating to investments as limited partners in Boulder Oil and Gas Associates (Boulder), Technology Oil and Gas Associates 1979 (Tech-1979), and Winfield Oil and Gas Associates (Winfield). Respondent disallowed these claimed losses and interest deductions, and petitioners filed the instant cases contesting respondent's adjustments.
After a lengthy trial in the
We did not, however, in the
As indicated, our findings and holdings in
The license agreements entered into by Boulder, Tech-1979, and Winfield with Elektra are not materially different from the license agreements entered into by the partnerships involved in the
Facts found and conclusions reached in
Similar to our findings in
In the oil and gas1997 Tax Ct. Memo LEXIS 453">*459 industry, a portfolio of technology is not ordinarily licensed when it is not known whether the technology will even work on the property on which the technology is to be implemented. EOR technology is known to be site specific. For this reason, the acquisition of a portfolio of EOR technology for use on particular properties typically does not occur in the oil industry.
In the late 1970's and early 1980's, when the license agreements involved in these cases were entered into, the established license fee in the oil industry for the right to use EOR technology was a 2-3 percent running royalty based on incremental increased oil production, or on the income actually realized therefrom, that was attributable to the particular EOR technology being licensed. The fixed fees to be paid by Boulder, Tech-1979, and Winfield for the EOR technology licenses were not competitive in the oil industry and were contrary to industry norms.
It was not necessary for Boulder, Tech-1979, and Winfield to license these technologies. Of the technologies licensed -- Carmel VaporTherm (Carmel), TEC, ElektraFlo, and SME Oil Drive -- only the TEC and Carmel processes were developed to any significant extent, 1997 Tax Ct. Memo LEXIS 453">*460 and the TEC and Carmel processes could have been licensed by the partnerships directly from the inventors thereof for running royalties based solely on income realized therefrom. Thus, it was not necessary for Boulder, Tech-1979, and Winfield to license the Carmel and TEC processes from Elektra and pay up-front fees for them.
In the oil exploration and production industry, it is ordinary to lease tar sands properties based on projections of reserves, not oil in place.
The multimillion dollar license fees and lease royalties that Boulder, Tech-1979, and Winfield agreed to pay were excessive, did not reflect arm's-length debt obligations, and are not to be recognized as legitimate obligations of the partnerships. The license fees and lease royalties to which Boulder, Tech-1979, and Winfield agreed, and the related debt obligations, do not constitute legitimate, genuine debt obligations and are to be disregarded.
On partnership information returns of Boulder, Tech-1979, and Winfield, petitioners were identified as partners, and on petitioners' respective individual Federal income tax returns for the years in issue, they reported their distributive share of the substantial claimed 1997 Tax Ct. Memo LEXIS 453">*461 losses and credits relating to Boulder, Tech-1979, and Winfield. By claiming these flowthrough partnership losses, petitioners repeatedly represented to respondent the existence of these partnerships and petitioners' status as partners of the partnerships.
It was the general partners and the promoters of Boulder, Tech-1979, and Winfield, not the limited partners, who controlled the transactions and activities of the partnerships. Actions and intent of the general partners with regard to Boulder, Tech-1979, and Winfield, including the profit objective of the partnerships or lack thereof, are attributable to petitioners. See
It is well established that the issue under section 183 as to whether partnerships are engaged in activity with a profit objective is determined at the partnership level.
In resolving this issue, courts focus on actions of the partners who manage affairs of the partnerships and upon whom other partners rely to make partnership decisions.
The U.S. Court of Appeals for the Ninth Circuit has repeatedly accepted the proposition that a partnership level determination of profit objective is proper. See, e.g.,
Analyzing under section 183 the profit objective element at the partnership level is consistent with and follows the general rule of Federal partnership taxation that the treatment of partnership income, loss, deduction, or credit be determined at the partnership level. Sec. 702(b);
Section 761(a) defines a partnership for Federal income tax purposes essentially as a group, joint venture, or other unincorporated organization through which any business, financial operation, or venture is carried on. See also
Petitioners argue that our holding in
Citing section 761(a) and section 301.7701-3(a), Proced. & Admin. Regs., petitioners argue further that partnerships lacking in profit objective are to be regarded as not engaged in any trade or business and that in such situations the1997 Tax Ct. Memo LEXIS 453">*466 partners' investments should be regarded as the mere coownership of property. We disagree.
Petitioners' specific arguments herein were rejected in
In
Petitioners cite certain court opinions out of context. In
References to partnership income in
In cases such as
For example, our focus in
As previously noted, finding that the underlying transactions entered into by the partnerships did not constitute arm's-length transactions, that the license fees agreed to were not negotiated at arm's length and were excessive, and that the assets acquired were overvalued, we held that the transactions entered into by the partnerships, upon which the losses in dispute were based, were not entered into with a profit objective, that the underlying transactions did not constitute legitimate for-profit business transactions, and that purported debt obligations associated therewith did not constitute genuine debt obligations and were to be disregarded. 2
1997 Tax Ct. Memo LEXIS 453">*470 The essence and focus of the inquiry as to whether an arrangement constitutes a partnership is whether the parties thereto intended to create a partnership. See, e.g.,
In
In
Boulder, Tech-1979, and Winfield did not constitute mere passive coowners of property. The partnerships entered into transactions, formed joint ventures, operated gas wells, and engaged in various other activities. They carried on a financial operation or venture. They are to be treated as partnerships under section 761(a) even though underlying activity of the partnerships lacked a profit objective under section 183.
Boulder, Tech-1979, and Winfield each had the formal indicia of partnership status and conducted themselves generally as partnerships. They are to be treated as partnerships. The issue under1997 Tax Ct. Memo LEXIS 453">*472 section 183 as to the profit objective of the partnership activity is to be analyzed at the partnership level. Our conclusion in
Our findings herein as to the lack of profit objective of the underlying activity of Boulder, Tech-1979, and Winfield are based in part on petitioners' failure to meet their burden of proof as to the existence of a profit objective with respect to the underlying activity of Boulder, Tech-1979, and Winfield, on the fact that the entire record and evidence of
Stare decisis may apply even though -- because the parties in the present case are not the same parties as were involved in the prior case -- res judicata would not apply.
We have applied stare decisis when faced with repetitive litigation involving the Federal income tax consequences of investments in related tax shelter partnerships. See
With regard to Tech-1979 and Winfield, on the one hand, and Technology-1980 (one of the partnerships involved in
Respondent's expert witness testified that although Tech-1979's and Winfield's license agreements had a somewhat different structure from Technology-1980's, they were not materially different. Petitioners have not alleged any differences between the license agreements of Boulder and Technology-1980.
We agree with respondent's expert that there were no material differences between the various license agreements of Boulder, Tech-1979, and Winfield and the license agreements of Technology-1980.
Petitioners have failed to show that the applicable findings of fact made in
In light of our resolution of the profit objective issue, 1997 Tax Ct. Memo LEXIS 453">*475 it is not necessary to address certain other substantive issues raised by the parties.
In our opinion in
For the years before us, section 6653(a) (1) provides additions to tax equal to 5 percent of the underpayments if any part of the underpayments are due to negligence or intentional disregard of rules or regulations. Section 6653(a) (2) provides an addition to tax of 50 percent of the interest on the portion of the underpayment attributable to negligence. Negligence under section 6653(a) (1) and (2) constitutes the failure to exercise due care or the failure to do what a reasonable or ordinarily prudent person would do under the circumstances.
With regard to our analysis of the additions to tax, it is important to note that one of respondent's own expert witnesses acknowledges that investors may have been significantly and reasonably influenced by the energy price hysteria that existed in the late 1970's and early 1980's to invest in EOR technology. A number of industry and governmental reports and publications encouraged investors to invest in EOR technology. Various governmental incentives, funding, and subsidies were directed at development of EOR technology. In the early 1980's, a large amount of money was spent on the development of technology for the recovery of oil from shale and synthetic fuels in spite of the fact that such technology was not technically viable at the time and that minimal oil was produced therefrom.
In evaluating the imposition of the additions to tax in the instant cases, and in light of the above facts (encouraging investments in and the development of tertiary oil recovery methods such as EOR technology), we are somewhat understanding of the individual investments1997 Tax Ct. Memo LEXIS 453">*477 that were made in the Boulder, Tech-1979, and Winfield partnerships. In the context of the hysteria relating to the energy crisis, the oil price increases of the late 1970's, the industry and governmental interest in EOR technology, the heavy and sophisticated promotion of these investments, and the evidence in these cases (and in spite of our findings and conclusions sustaining respondent's substantive tax adjustments), we conclude that petitioners are not liable for the additions to tax under section 6653(a) (1) and (2).
For 1981 and 1982, respondent in these cases, on brief, has conceded the section 6659 additions to tax.
For 1982, respondent asserts that petitioners, John and Cornelia Vanderschraaf, are liable for an addition to tax for substantial understatement of tax under section 6661, equal to 25 percent of the respective underpayment of tax attributable to such understatement of tax. In order for an understatement of tax to be considered substantial, the amount of the understatement must exceed the greater of 10 percent of the tax required to be shown on the Federal income tax return or $ 5,000. Sec. 6661(b) (1) (A). Respondent contends that the addition to tax under section1997 Tax Ct. Memo LEXIS 453">*478 6661 should be imposed because there was no substantial authority supporting the claimed treatment of the disallowed items. Petitioners argue that they should be held not liable for the section 6661 addition to tax and that respondent should have waived the section 6661 addition to tax.
Respondent also argues that petitioners never formally requested respondent to waive the section 6661 addition to tax, and respondent argues that the Court therefore is without jurisdiction to review respondent's refusal to waive this addition to tax.
On the record in these cases, we conclude that the section 6661 addition to tax has always been before the Court and in dispute between the parties. Respondent has been aware for years of petitioners' request for an abatement thereof.
In the related test case of
As we explained in
For the reasons stated, respondent's imposition of the additions to tax is not sustained in these cases, 1997 Tax Ct. Memo LEXIS 453">*480 but respondent's imposition of increased interest under section 6621(c) is sustained.
Footnotes
1. Cases of the following petitioners are consolidated herewith: Estate of Donald R. Lawrenz, Sr., Deceased, Donald R. Lawrenz, Jr., Executor, and Ella A. Lawrenz, docket No. 6079-88; John C. Vanderschraaf and Cornelia Vanderschraaf, docket No. 8910-88; and Estate of Donald R. Lawrenz, Sr., Deceased, Donald R. Lawrenz, Jr., Executor, docket No. 21729-88.
Petitioner Donald R. Lawrenz, Sr., died on Sept. 7, 1996.↩
2. It is noted that the Court made these findings in
, affd. sub nom.Krause v. Commissioner , 99 T.C. 132">99 T.C. 132 (1992) (10th Cir. 1994), with respect to a sister partnership, Technology-1980.Hildebrand v. Commissioner , 28 F.3d 1024">28 F.3d 1024↩