Opinion
Docket Nos. 8040-73 — 8043-73, 8063-73, 8104-73.
Filed October 9, 1975.
Petitioners owned the stock of Raybert Productions, Inc. (Raybert), which, in turn, owned a motion picture named "Easy Rider" and a television program known as "The Monkees." Raybert had a distribution contract entitling it to payments from Columbia Pictures Industries, Inc., based upon monthly accounting periods with respect to "Easy Rider," and a similar contract with respect to "The Monkees" entitling it to annual payments on Nov. 30 from Screen Gems, Inc., for each fiscal year ending July 23. On May 23, 1970, Raybert was liquidated, and its assets were distributed to petitioners. Held, the "Easy Rider" monthly payment for April 1970 is taxable to Raybert, and petitioners are liable as transferees for the tax thereon, but no part of the "Easy Rider" payment for May 1970 or "The Monkees" annual payment is taxable to Raybert. Held, further, petitioners' taxable income for 1970, which included the gain on the liquidation distribution from Raybert, may not be adjusted for their liability as transferees of Raybert's assets. Held, further, petitioners are not entitled to recover their basis in the assets received on the liquidation of Raybert before recognizing any income therefrom.
Hilbert P. Zarky, for the petitioners.
Jonathan A. Brod, for the respondent.
Respondent determined the following deficiencies in petitioners' Federal income tax for 1970:
Docket No. Amount
8040-73 ......................................... $22,529 8043-73 ......................................... 17,787 8063-73 ......................................... 36,547
Respondent also determined a deficiency of $336,820 in the corporate income tax of Raybert Productions, Inc. (Raybert), a dissolved corporation, for the year ending June 30, 1970, and further determined that petitioners in docket Nos. 8041-73, 8042-73, and 8104-73 were liable under section 6901 as transferees of Raybert. Petitioners do not dispute their liabilities as transferees if the underlying income tax deficiencies are due, but they contest the determined deficiencies. The following issues are presented for decision:
All section references are to the Internal Revenue Code of 1954, as in effect during the year in issue, unless otherwise noted.
(1) What part, if any, of certain payments received by petitioners under two contracts distributed to them as part of the liquidation distribution of Raybert is taxable to the liquidated corporation?
(2) If Raybert owes any income tax deficiencies for which petitioners are liable as transferees, whether petitioners are entitled to any adjustment in their individual tax liabilities for 1970, the year they received and were taxed upon the value of Raybert's assets distributed in liquidation?
(3) Whether petitioners, in their individual capacities, are required to report the income received by them under contracts distributed to them on Raybert's liquidation pursuant to the "income forecast method" or are they entitled to recover their basis in the contracts prior to recognizing any of the payments as taxable ordinary income?
FINDINGS OF FACT 1. General
Petitioners were legal residents of Los Angeles, Calif., at the time their respective petitions were filed. They filed their Federal income tax returns for 1970 with the District Director of Internal Revenue, Los Angeles, Calif.
Raybert Productions, Inc. (hereinafter Raybert), was a corporation organized under the laws of the State of California on April 12, 1965. It had its principal place of business in Los Angeles, Calif. Raybert reported its income on the basis of a fiscal year ending June 30, employing the cash receipts and disbursements method of accounting. It filed its final corporate income tax return with the District Director of Internal Revenue, Los Angeles, Calif. One-half of Raybert's 30 outstanding shares was owned by petitioners Berton and Judith Schneider, as their community property, and one-half by petitioners Robert J. and Toby Carr Rafelson, as their community property.
2. "Easy Rider"
Prior to April 30, 1969, Raybert had acquired all rights in a feature-length motion picture entitled "Easy Rider." On that date, Raybert entered into an agreement with Columbia Pictures Industries, Inc. (hereinafter Columbia), whereby the latter was granted the right to rent, lease, license, exhibit, distribute, and otherwise dispose of the motion picture or any prints thereof for a period of 21 years. Columbia undertook to maximize the gross receipts from exploitation of the film and to utilize its best efforts consistent with sound business policy in that undertaking. All decisions relating to the distribution of the picture were left to the good business judgment of Columbia. The term of the agreement can be automatically extended in perpetuity unless and until certain purchase rights provided in the agreement are exercised.
The function of a distributor, such as Columbia, is to exploit the film in any manner that will maximize its economic return. Once the film is produced, the distributor decides how the film is to be marketed. This includes decisions as to the manner and extent of advertising as well as the scheme for the exhibition of the film.
The distributor, in the exercise of its discretion, decides upon the number and places of initial exhibitions as well as subsequent exhibitions. Agreements are then executed by the distributor with owners of theaters or chains of theaters, referred to as exhibitors. These agreements are often subject to change or renegotiation at a later date. Agreements with exhibitors vary but, as a general rule, the distributor receives a specified percentage of the box office receipts in exchange for granting the right to exhibit the film.
Once an exhibition plan is prepared and agreements concluded with exhibitors, prints of the film must be manufactured and delivered to the exhibitors. Color prints for an average motion picture cost approximately $650 per print. In addition, the film must be advertised. The extent of advertisement, choice of media, and other relevant decisions are left entirely to the distributor, and a method, once chosen, may be changed if the distributor so decides. Advertising and manufacturing of prints are the largest expenses involved in distributing a film.
As time passes, the film may be shelved for later reissue, either separately or double-billed with another film. In the event it is double-billed, the distributor must allocate expenses and receipts between the double-billed films.
Other decisions made by the distributor include those relating to syndication of the film for television viewing and production and distribution of foreign language editions of the film. With respect to the latter, decisions must be made whether to "dub" the film or use subtitles. In addition, as in the case of domestic showings, decisions must be made with respect to advertising, shelving, reissuing, and adapting the film for television use.
In the instant case, Raybert's agreement with Columbia with respect to "Easy Rider" provided that Columbia's gross receipts would be applied toward the payment of (a) trade association fees and (b) taxes. In addition, Columbia was to be paid its distribution fees, consisting generally of a charge of 30 percent of the balance of the gross receipts derived from licensing in the United States, 30 percent from Great Britain and Canada, and 37 1/2 percent from other countries; 10 percent from sales; and 25 percent from licensing for television showings. The remainder of the gross receipts is referred to as the "production share of gross receipts." From this remainder, Columbia was to recoup its print costs, advertising expenses, and other advances. After certain further adjustments were made, Columbia was to receive one-third and Raybert two-thirds of the remaining net proceeds. From its share Raybert was to pay the Pando Corp., from which it had acquired the film, one-third of the net proceeds. The agreement also contains provisions for handling foreign currency transactions.
Columbia agreed to furnish Raybert with monthly statements, accompanied by payments, for a period of 18 months after the release of the picture and thereafter semiannually. The statements were to show Columbia's receipts and billings within each distribution territory relating to the preceding month or semiannual period. In addition, the statements were to show the permitted deductions from gross receipts. These statements were to be submitted — within 45 days with respect to United States transactions and 120 days with respect to foreign transactions — after the close of the period for which each statement was made.
Raybert had a limited right to inspect Columbia's records, as they related to "Easy Rider," for the purpose of checking the accuracy of the accounting statements. Exercise of this right had to be elected within 18 months after delivery of the statements in accordance with the following provision:
Nothing herein contained shall be deemed to give you the right to go into any matters or items which make up any of the items contained in any such statement, if inquiry into same shall require an examination of our records or books after the expiration of 18 (eighteen) months from and after the date of any statement questioned by you, it being the intention hereof that statements not questioned by you by notice in writing within said 18 (eighteen) month period shall be final and conclusive account stated. You shall be forever barred from maintaining or instituting any action or proceeding based upon, or involving, or in any wise relating to, or pertaining to, or concerning any transactions had by us, our affiliates or our or their licensees in connection with the Picture and the accounting embraced in any statement delivered hereunder or the accuracy of any item appearing therein, unless such written objection shall have been delivered by you to us within 18 (eighteen) month period mentioned in Paragraph 2 of this Article and unless such action or proceeding is commenced within 6 (six) months after the delivery of such written objection by you to us.
The agreement also provided:
Nothing in this Agreement contained shall be construed, deemed or interpreted to mean that any moneys due or payable to you hereunder are held in trust by us for you, it being the express intention hereof that such is not the case and that we shall have the right to commingle any part or portion of the sums payable to you out of or on account of the gross proceeds which may be received by us with any of our own moneys and to make use thereof without restriction, being indebted to you only for the amounts to which you are entitled hereunder at the time when sums shall be expressly payable to you hereunder.
In the event of breach of any obligation under the agreement constituting a default on Columbia's part, Raybert was entitled to institute an appropriate action for relief. The agreement further recited:
In no event, however, shall the rights herein acquired by us [Columbia] be subject to revocation or termination notwithstanding any such failure, breach or default of any kind on our part.
3. "The Monkees"
On or about April 16, 1965, Raybert entered into an agreement with Screen Gems, Inc. (hereinafter Screen Gems), a controlled subsidiary of Columbia, relative to the production and distribution of a certain television program, which was later known as "The Monkees." The provisions with respect to the distribution relationship of the parties and the sharing of the profits of "The Monkees" are similar to the "Easy Rider" agreement in all relevant respects, with the exception that "The Monkees" agreement provided for annual accounting statement periods ending July 31.
4. Raybert's Dissolution and Distributions
On May 23, 1970, Raybert's stockholders elected to dissolve the corporation. Accordingly, in pursuance of the plan of liquidation and dissolution, Raybert distributed all of its interest in "The Monkees" and "Easy Rider" to its shareholders.
On June 19, 1970, Columbia issued statement No. 9 with respect to "Easy Rider" for the 1-month period ended April 25, 1970, and accompanied such statement with a check in the amount of $164,040.48 payable to Berton Schneider and Robert Rafelson. The statement and check were received on June 22, 1970.
There is no explanation in the record why this statement covered a period ended Apr. 25, 1970, rather than Apr. 30, 1970. The next statement covered the period ended May 30, 1970.
On August 7, 1970, Columbia issued its statement No. 10 with respect to "Easy Rider" for the 1-month period ended May 30, 1070, and accompanied such statement with a check in the amount of $854,248.32 payable to Berton Schneider and Robert Rafelson. Such statement and check were received on August 10, 1970.
Statements Nos. 9 and 10 reported receipts and expenditures from foreign as well as domestic territories. The agreement allowed Columbia 120 days to compute the results from operations in foreign territories. However, the statements do not clearly show whether the figures with respect to foreign territories were derived from the same monthly period as those relating to domestic receipts or from an earlier period as allowed under the agreement. Respondent did not raise this issue and it is inferred therefore that the figures relating to all territories were derived from operations during the same monthly periods.
On November 30, 1970, Screen Gems, having previously been informed that all of Raybert's rights in "The Monkees" had been distributed to its shareholders, transmitted its statement relative to "The Monkees" for the year ended July 23, 1970, together with a check in the amount of $199,888.08 payable to Berton Schneider and Robert Rafelson. Such statement and check were received on December 4, 1970.
Being advised that Raybert's shareholders would be required to include in their individual income tax returns the fair market value of the assets received by them on the liquidation of the corporation, petitioners' accountant met with various officials of Columbia and Screen Gems, prior to the time Raybert was liquidated, for the purpose of obtaining their best estimates of future earnings. At this meeting no one gave overall estimates of the value of the assets — some restricted themselves to domestic receipts, others to foreign receipts, etc. Columbia often used such estimates for business-planning purposes and for specific distribution plans.
From the information thus obtained, the accountant arrived at ultimate reportable values. These values were utilized in computing the amount realized in the liquidation distributions of Raybert.
The estimates of total future earnings compiled by the accountant relating to "Easy Rider" totaled $24,850,000. Although the accuracy of the estimates of earnings from separate sources varied greatly, total receipts as of September 30, 1974, equaled $24,931,477. The estimate compiled by the accountant for receipts from all sources for "The Monkees" was $546,163. The actual receipts as of July 28, 1973, were $578,398. Petitioners recovered their basis in "Easy Rider" sometime prior to January 26, 1974, and in "The Monkees" prior to July 28, 1973.
Raybert filed its final corporate income tax return for the year ending June 30, 1970. Pursuant to section 446(b), respondent determined a deficiency in Raybert's income taxes by including all of "Easy Rider" payment No. 9, portions of "Easy Rider" payment No. 10, and "The Monkees" annual payment in Raybert's income for its final taxable year. Respondent apportioned the latter two payments by use of a fraction, the denominator of which was the length of the accounting period in days and the numerator of which was the length of time in the accounting period, also expressed in days, during which Raybert owned the contract. Respondent also determined deficiencies in petitioners' individual income taxes for 1970 by using the "income forecast" method of amortizing the contracts received by petitioners.
OPINION 1. Allocation of Income under Section 446
The cash receipts and disbursements method of accounting used by Raybert is one of the acceptable accounting methods prescribed by section 446(c). Since the payments under "Easy Rider" statements Nos. 9 and 10 and "The Monkees" annual statement for the year ended July 23, 1970, had not been received when Raybert was liquidated on May 23, 1970, petitioners did not include those payments in the corporation's final taxable period. Respondent argues that prior to its liquidation, Raybert had "earned" the full amount of the payment on "Easy Rider" statement No. 9 and a proportionate part of the payments on "Easy Rider" statement No. 10 and "The Monkees" annual statement. Relying upon section 446(b), respondent seeks to include those payments in Raybert's taxable income for its final taxable period by recomputing Raybert's income under the accrual method of accounting.
SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING.
(c) PERMISSIBLE METHODS. — Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting —
(1) the cash receipts and disbursements method;
(2) an accrual method;
(3) any other method permitted by this chapter; or
(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary or his delegate.
Sec. 446(b) provides as follows:
(b) EXCEPTIONS. — If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.
Petitioners vigorously deny that Raybert, no longer in existence when the payments were received, had "earned" any of the disputed amounts attributable to the "Easy Rider" and "The Monkees" payments. They maintain that neither the accrual method of accounting nor any other recognized accounting method would include these payments in Raybert's income, and they argue that, within the meaning of section 446(b), respondent's determination distorts rather than "clearly reflect[s]" the corporation income for its final taxable period.
Although the notice of deficiency reflects that sec. 482 is an alternative ground for the determination, respondent apparently abandoned this point on brief. Significantly, the notice of deficiency does not purport to "allocate" the income between any two parties but merely seeks to tax such income to Raybert. See South Lake Farms, Inc., 36 T.C. 1027, 1042 (1961), affd. 324 F.2d 837 (9th Cir. 1963).
We are thus presented with the often-litigated question of whether payments received by the shareholders of a liquidating corporation with respect to assets distributed in liquidation are properly taxable to the corporation as income in its final taxable period or are properly taxable to the shareholders. See, e.g., Idaho First National Bank v. United States, 265 F.2d 6 (9th Cir. 1959); Standard Paving Co. v. Commissioner, 190 F.2d 330 (10th Cir. 1951), affg. 13 T.C. 425 (1949); Jud Plumbing Heating v. Commissioner, 153 F.2d 681 (5th Cir. 1946), affg. 5 T.C. 127 (1945); Susan J. Carter, 9 T.C. 364 (1947), affd. 170 F.2d 911 (2d Cir. 1948). The rule to be gleaned from these cases is that a corporation is taxable on income which was "earned," or "accrued," or "realized," prior to its liquidation. Whether the words used are "belonged to," "earned," or "accrued," they all refer to "a taxpayer's fixed and determinable rights in a certain amount of income." (Emphasis supplied.) Shea Co., 53 T.C. 135, 156-157 (1969).
The legal premise of these cases has been expressed as follows ( Jud Plumbing Heating v. Commissioner, 153 F.2d 681, 684 (5th Cir. 1946), affg. 5 T.C. 127 (1945)):
"it is a fundamental concept of taxation that income is chargeable to him who earns it, * * *
* * *
"A corporation being a separate legal entity, its net earnings, whether ascertained or not, belong to it, * * * and this liability cannot be discharged by the simple expedient of dissolution and the turning over of all its assets, including current and unreported income, to its sole stockholder, * * *"
The rule, while easily stated, is not so easily applied to given factual situations. Application of the rule is guided by the fundamental principle that: "The dominant purpose of the revenue laws is the taxation of income to those who earn or otherwise create the right to receive it." Helvering v. Horst, 311 U.S. 112, 119 (1940); see Williamson v. United States 155 Ct. Cl. 279, 283-287, 292 F.2d 524, 527-529 (1961); Jud Plumbing Heating, Inc., 5 T.C. at 133. This pervasive "purpose" has led courts to allow respondent considerable discretion under section 446(b) to apply a method of accounting to the liquidating corporation's final taxable period which accurately reflects the reality of who earned or realized the income in question. See Idaho First National Bank v. United States, supra at 9; Standard Paving Co. v. Commissioner, 190 F.2d at 332; Floyd v. Scofield, 193 F.2d 594, 596 (5th Cir. 1952). The issue is basically factual, and each case turns on its own facts
The law is settled that the Commissioner has authority under sec. 446(b) to recompute an item of a liquidating corporation's income under the accrual method of accounting even though the corporation has used the cash method in computing its income. See, e.g., Williamson v. United States, 155 Ct. Cl. 279, 287, 292 F.2d 524, 530 (1961); Idaho First National Bank v. United States, 265 F.2d 6, 9 (9th Cir. 1959); J. Ungar, Inc. v. Commissioner, 244 F.2d 90 (2d Cir. 1957), affg. 26 T.C. 331 (1956); Floyd v. Scofield, 193 F.2d 594 (5th Cir. 1952).
While we recognize that section 446(b) gives respondent broad discretion, we sustain respondent's position only with respect to the payment under "Easy Rider" statement No. 9. The other disputed payments are not taxable to Raybert.
(a) "Easy Rider" statement No. 9. — The "Easy Rider" distribution agreement provided that Columbia would account on a monthly basis for all moneys payable to Raybert. The amounts payable to Raybert were determined by the difference between gross receipts from the picture and the allowable deductions for expenses and Columbia's fees for its services. All the relevant figures were computed on a monthly basis, and Raybert was entitled to a payment only if the gross receipts exceeded permissible deductions during the month.
The month of April 1970, covered by statement No. 9, had expired prior to Raybert's liquidation, and Raybert's right to its percentage of the net proceeds under the "Easy Rider" agreement was subject to accurate computation. By that date, all the events had occurred which fixed the amounts receivable from Columbia's right to rent, lease, license, exhibit, distribute, or otherwise dispose of the picture and prints thereof. Similarly, by that date, all expenses payable on account of those receipts were subject to determination with reasonable accuracy.
Thus, at the time of the liquidation, all the events necessary to fix the net amount earned during that period had occurred. Raybert had done everything necessary to perfect its right to the income; only the ministerial act of computation remained to be done. Cf. Continental Tie L. Co. v. United States, 286 U.S. 290, 295 (1932); Marquardt Corp., 39 T.C. 443, 457 (1962). We think Raybert's rights were sufficiently fixed and determinable to justify respondent's allocation to Raybert of the amount ultimately received pursuant to statement No. 9 as a means of clearly reflecting Raybert's preliquidation income. See Jud Plumbing Heating v. Commissioner, 153 F.2d at 684; Standard Paving Co. v. Commissioner, 190 F.2d at 332-333; Commissioner v. Kuckenberg, 309 F.2d 202, 207-208 (9th Cir. 1962), affg. on this issue 35 T.C. 473 (1960).
Petitioners' argument that they did not know the amount payable under statement No. 9 does not aid their cause. Under section 1.446-1(c)(1)(ii), Income Tax Regs., income is includable in taxable income for the year when "all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy." See Spring City Co. v. Commissioner, 292 U.S. 182, 184-185 (1934). The exact amount need not be determined if all the facts upon which the calculation depends have become fixed. It is sufficient if the amount is knowable even if it is not known. Jud Plumbing Heating v. Commissioner, 153 F.2d at 684; Dally v. Commissioner, 227 F.2d 724, 726-727 (9th Cir. 1955), affg. 20 T.C. 894 (1953), cert. denied 351 U.S. 908 (1956).
In the instant case all the relevant facts were fixed and "knowable" as of the end of the April accounting period. True, Columbia, and not petitioners, possessed the data necessary for calculation of the amount owed. However, there is no evidence that on May 23, 1970, Raybert was incapable of obtaining an estimate of the amount due for the April accounting period. Petitioners were aware of the existence of Columbia's obligation, unlike the taxpayer in Camilla Cotton Oil Co., 31 T.C. 560 (1958), but made no attempt to secure an estimate of the amount owed. Cf. George K. Herman Chevrolet, Inc., 39 T.C. 846, 850 (1963). Under such circumstances, we think the statement No. 9 payment was properly includable in Raybert's final tax year.
The liquidation occurred on May 23, 1970, nearly 1 month after the close of the April accounting period. The statement was issued on June 19, 1970, and there is nothing in the record to indicate an earlier estimate was not possible.
(b) "Easy Rider" statement No. 10 and "The Monkees" annual statement. — The precedents cited above dictate a different result with respect to the other disputed payments — the "Easy Rider" statement No. 10 payment and "The Monkees" annual payment. In both cases, Raybert had no fixed determinable right to an ascertainable amount of income at the time of its liquidation.
First, as a matter of contract, Raybert's rights had not fully ripened. See Schlude v. Commissioner, 372 U.S. 128 (1963). As explained above, Raybert's legal right to payments depended upon the outcome of each accounting period. By the terms of the contracts between the parties, Raybert's right to income became fixed only if the transaction during the entire accounting period yielded "net proceeds." Thus, prior to the close of the accounting period Raybert had no legal right to any payment whatsoever. In short, nothing was due and owing Raybert on these statements on the date of liquidation. Williamson v. United States, 292 F.2d at 529; Telephone Directory Advertising Co. v. United States, 135 Ct. Cl. 670, 677-678, 142 F. Supp. 884, 888 (1956).
As a factual matter, the existence of net proceeds was subject to significant contingencies. The amount of such net proceeds ultimately realized depended upon Raybert's share of the box office proceeds realized by the exhibitors as well as the amounts of expenditures incurred by Columbia. Until the expiration of the relevant accounting period, there were many contingencies that could alter or erase any net proceeds Raybert might have expected to receive. For example, Columbia had complete discretion to incur expenses for advertising, prints, or other permissible purposes, which could reduce or entirely eliminate any net proceeds during a particular accounting period. Similarly, gross receipts could be affected by a wide variety of factors, such as the cancellation or renegotiation of exhibition agreements or unexpected competition with more popular films. These contingencies compel the conclusion that, at the time of its liquidation, Raybert had not "earned" any part of the income ultimately received under "Easy Rider" statement No. 10 and "The Monkees" annual statement for the year ended July 23, 1970. See, e.g., Telephone Directory Advertising Co. v. United States, supra; United States v. Horschel, 205 F.2d 646, 648 (9th Cir. 1953); United Mercantile Agencies, 34 T.C. 808, 817 (1960).
Respondent's proration of these payments not only ignores the agreement between Columbia and Raybert, but does not correspond to the reality of how the income was earned. Respondent's allocation rests on the facile assumption that the net proceeds were realized approximately on a ratable daily basis over the respective accounting periods. Respondent contends that, in the absence of a contrary showing by petitioners, this allocation constitutes a reasonable ascertainment of the amount earned by Raybert to the date of its liquidation. This assumption is wholly unrealistic. "Easy Rider" statement No. 10 reflects the net amount computed from receipts from no less than 24 foreign countries and expenditures falling into 17 broad categories. As noted above, Raybert's contract with Columbia anticipates that income will be derived from numerous methods of marketing the picture. Similarly, "The Monkees" statement for the taxable period ended July 23, 1970, shows domestic royalties from sales of 11 single records and 10 albums, plus royalties from 38 foreign countries, together with a wide variety of types of expenditures. The amounts ultimately received pursuant to the several statements varied widely — ranging from $375,113 to $949,635 on "Easy Rider" statements Nos. 4 through 7. Indeed, $164,040.48 was received on statement No. 9 and $854,248.32 on statement No. 10. To say that a ratable portion of the amounts ultimately received pursuant to these statements had been realized, i.e., "earned," when Raybert was liquidated would be pure conjecture. On this ground George K. Herman Chevrolet, Inc., supra, is clearly distinguishable.
2. Adjustment of Amount Received for Transferee Liability
In conjunction with the preceding arguments, petitioners contend that, if they are liable as transferees for any tax with respect to the "Easy Rider" and "The Monkees" payments, they are entitled to have the value of the amount received as liquidation distribution from Raybert adjusted by the amount of such liability. They argue that if the payments were really earned by, and are taxable to the corporation, the value of the liquidation assets they received was less than the amount reported and that this fact should be reflected by a reduction of the gain they realized on Raybert's liquidation.
Respondent, citing Roberta Pittman, 14 T.C. 449, 451-452 (1950), and Estate of Henry E. Mills, 4 T.C. 820, 827-828 (1945), answers that petitioners are not entitled to the claimed adjustment in 1970. Rather, petitioners may deduct the taxes paid as a result of their transferee liabilities as a loss for the year in which such liabilities are paid.
On the authority of the cases cited by respondent as well as Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and James Armour, Inc., 43 T.C. 295, 312 (1964), all of which we find indistinguishable in principle, we agree with respondent and hold accordingly. Tax liabilities are computed on an annual basis. Burnet v. Sanford Brooks Co., 282 U.S. 359 (1931). Petitioners received the full amount of the distribution from Raybert in 1970, unreduced by any corporate taxes on the "Easy Rider" statement No. 9 payment. Petitioners may be entitled to a deduction for additional corporate taxes attributable to statement No. 9 as a loss in the year in which they are paid, but they are not entitled to the adjustment which they claim in their 1970 tax liability.
3. Amortization of Raybert's Assets
On their 1970 Federal income tax returns, petitioners reported and paid a capital gains tax on the difference between their cost basis in Raybert's stock and the value of the assets received in the liquidation. However, petitioners reported no income on their Federal income tax returns for the payments received under the distribution contracts during 1970. Petitioners argue that before any income can be realized they must first recover their basis in the contract rights. Petitioners contend the use of this "cost-recovery" method is justified, because the nature of the investment is highly speculative and it is therefore uncertain whether their investment will be recouped, citing Burnet v. Logan, 283 U.S. 404 (1931). In addition, petitioners assert that the method advocated by respondent distorts the income realized on the contracts.
The basis is a sum equal to the fair market value of the contract rights which was employed in computing the tax due from the shareholders (petitioners) upon liquidation of Raybert.
In the notice of deficiency, respondent determined that the "income forecast" method of amortizing the contracts applies. Pursuant to this method an estimate of income to be derived from the contracts is calculated, and in each year petitioners may amortize that part of their basis which bears the same ratio to the total basis as the payments received in the year bear to the total estimated payments.
The controlling statute is section 167(a) which provides that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion of property held for the production of income. The term "property" includes intangible contract rights, and such rights are subject to a depreciation allowance. See KIRO, Inc., 51 T.C. 155, 167 (1968); David Hoffman, 48 T.C. 176 (1967); see also Computing Software, Inc., 64 T.C. 223(1975).
Respondent has recognized the difficulties associated with amortizing film contract rights in Rev. Rul. 60-358, 1960-2 C.B. 68. Because of the uneven flow of income earned by this type of property, and because the usefulness of such assets is best measured by the flow of income and not solely by the passage of time, respondent accepted the income forecast method as a method of amortization under section 167. See also Rev. Rul. 64-273, 1964-2 C.B. 62. This method, as employed in the instant case, results in a fair allocation of the basis of the asset to periods in which income is realized and gives petitioners a reasonable allowance for amortization. Massey Motors, Inc. v. United States, 364 U.S. 92 (1960).
Petitioners' argument is founded on the factual premise that petitioners' investment in the contract rights was highly speculative and the income to be received not capable of sufficiently accurate estimation to permit the computation of a reasonable amortization allowance. Not only does the record lack real support for this assertion, but, to the contrary, the record is replete with evidence that petitioners were virtually certain to recover their bases in the contracts. We need only list these facts:
As a matter of law, petitioners' reliance upon Burnet v. Logan, 283 U.S. 404 (1931); Commissioner v. Liftin, 317 F.2d 234 (4th Cir. 1963); Willhoit v. Commissioner, 308 F.2d 259 (9th Cir. 1962), is misplaced. As explained in Inter-City Television Film Corp., 43 T.C. 270, 293 (1964), involving the applicability of the cost recovery method to film exhibition contract rights:
"Those cases [ Burnet v. Logan and its progeny] were not concerned with proper methods of depreciation but with the proper time for reporting income, if any, from transactions so speculative in nature that the taxpayer is not reasonably certain of ever recovering his investment. The problems are different and we do not believe that the rationale of those cases has a ready application to the problem of a current method of depreciation. * * *"
(1) Petitioners valued the contracts as of the date of liquidation on the basis of an estimate of future income and paid a tax based thereon. Having ascertained a fair market value for this purpose, it is too late to argue that such predictions are impossible or unreliable. See Waring v. Commissioner, 412 F.2d 800, 801 (3d Cir. 1969).
(2) Joseph A. Fischer, financial vice president and treasurer of Columbia, testified that estimates of future income from films are often compiled by the distributor, made a part of its records, and relied upon for general business planning purposes and for distribution decisions with respect to specific films.
Petitioners also suggest that the income forecast method results in distortions of income. However, that method allocates the basis to the years the asset earns income and results in a substantially accurate apportionment of the amortization of petitioners' basis. If the estimates prove to be inaccurate, adjustments can be made, thus correcting any possible distortions of income.
Petitioners also argue that, while they were required to value the contracts on liquidation according to the best data available in order to pay a tax thereon, that value, based on future earnings, may not necessarily be an accurate estimate for amortization purposes. Therefore, the argument goes, valuation for amortization purposes should not be required. It cannot be gainsaid that valuation for liquidation purposes was required. However, estimation is no less necessary under the tax law for amortization purposes. "[P]rediction is the very essence of depreciation accounting," Massey Motors, Inc. v. United States, 364 U.S. at 105, and the difficulty of prediction does not render it unnecessary. Inter-City Television Film Corp., 43 T.C. 270, 292 (1964).
To reflect the foregoing,
Decisions will be entered under Rule 155.