Source: https://en.m.wikisource.org/wiki/Erhard_Seminars_Training_v._C.I.R._Docket_Nos._6283-75,_9220-76,_6249-78,_820-79,_4857-80,_1408-81._(1986)
Timestamp: 2019-04-23 17:17:30+00:00

Document:
Docket Nos. 6283-75, 9220-76, 6249-78, 820-79, 4857-80, 1408-81. Filed October 23, 1986.
Docket Nos. 6283-75, 9220-76, 6249-78, 820-79, 4857-80, 1408-81.
Jay T. Youngdahl and Arthur Sadin, for the petitioner. Stephen M. Miller, for the respondent.
Some of the facts were stipulated and they are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
Saratoga Restaurant Equipment Co. (Saratoga) was incorporated under the laws of the State of California on May 5, 1969. Saratoga was a shell corporation which never engaged in any business activities. On October 4, 1971 the Board of Directors of Saratoga resolved to do business under the name of Erhard Seminars Training. A Certificate of Amendment changing Saratoga's name to Erhard Seminars Training, Incorporated (EST) was executed on October 21, 1971 and was filed with the California Secretary of State on December 20, 1971. On November 14, 1975 the Board of Directors of EST resolved to change the name of EST to Twine, Inc. (Twine) and the name was officially changed on January 2, 1976. On December 20, 1976 Twine resolved to liquidate and a Certificate of Winding Up and Dissolution was filed with the California Secretary of State on December 15, 1977. The term petitioner will hereinafter refer to Saratoga, EST or Twine, as appropriate.
Petitioner filed its Federal income tax returns for the taxable years ended April 30, 1972 through April 30, 1977 and for the taxable period May 1, 1977 through December 31, 1977 with the Fresno Service Center.
FN** This amount represents gross income for the period of 5/1/75 through      8/31/75.
Petitioner reported no distributions from retained earnings during the taxable years ended April 30, 1972 through April 30, 1976. Petitioner reported a distribution of property in the amount of $4,334,021 during the taxable year ended April 30, 1977 describing it as a partial liquidation distribution pursuant to section 337. Petitioner reported a final liquidating distribution in the amount of $400,761 on its return for the taxable period ended December 31, 1977.
Werner Erhard (hereinafter Erhard), president, Elaine Cronin, vice- president and K. Laurel Scheaf (hereinafter Scheaf), secretary- treasurer. Scheaf became secretary-treasurer at the request of Erhard. Harry Margolis (hereinafter Margolis) was the attorney for petitioner from its inception through 1975 and subsequently was the attorney for est, An Educational Corporation.
Prior to 1971 Erhard worked for various corporations including Parent's Enterprises, the Great Books Corporation and the Grolier Society. In 1971 he became an instructor for Mind Dynamics and while so employed he developed his own concepts which he was anxious to pursue. Erhard, together with his attorney Robert Dunnett (hereinafter Dunnett), discussed this matter at a meeting with representatives of Mind Dynamics. Dunnett was an attorney in the office of Margolis whom Erhard had previously consulted. After the meeting Erhard rejected an offer to become a senior executive of Mind Dynamics and decided to disassociate himself from Mind Dynamics entirely and to devote his efforts to his new concepts. Erhard, in discussing with Margolis and Dunnett the appropriate vehicle for the new enterprise, emphasized that among other considerations he wanted a profit-making structure.
On October 4, 1971 the following individuals were elected as officers of petitioner: Erhard, president, Elaine Cronin, vice- president, Scheaf, secretary-treasurer.
Director HELFRICK moved that the corporation adopt the resolution stating that the Saratoga Restaurant Equipment Company, Inc. which formerly had located its headquarters in Los Angeles, was properly now being located in Saratoga, and was no longer functioning as a restaurant equipment company, but as an organization for the development of human consciousness. The resolution stated: 'That the use of the Saratoga Restaurant Equipment Company, Inc. corporation entity for the purposes of Erhard Seminar Training, Inc., was a pure accident, and that there was no relationship between the functions and purposes of the restaurant equipment company with those of the Erhard Seminars Training. The purpose of one, having been inactive, only left a vacuum whereby the new function could start from the ground floor and upon which to build. In fact Erhard Seminars Training is starting totally new, and creating itself out of a vacuum in the first instance.' This motion was seconded by Director REINHARDTSEN. After discussion was held among the Directors concerning the motion, on the affirmative vote of a majority of the Directors present, it was resolved that the Saratoga Restaurant Equipment Company, Inc. has no relationship in purpose or function to that of Erhard Seminars Training, Inc. and Erhard Seminars Training, Inc. is creating itself totally free from any of the Saratoga Restaurant Equipment Company, Inc. purposes.
On October 17, 1975 all of petitioner's officers and directors (with the exception of Margolis) resigned and were replaced by Margolis, president and chairman of the board, Doxie Gore, vice-president and director and Thomas Meeham, secretary-treasurer and director. Thomas Meeham had been employed as petitioner's accountant from January through September 1974 at which time he went to work in the Margolis office.
Erhard originated the material and created the product marketed by petitioner. He was a central figure in petitioner's operations and was closely involved in the financial aspects of petitioner.
Margolis, whom Erhard had consulted in 1971 with respect to the initiation of Erhard's new enterprise, generally implemented tax planning for his clients through use of 'planning memoranda' which directed the requisite tax planning steps to be followed. A 'planning memorandum' contained drafts of documents necessary for the execution of the transactions involved. On occasion, documentation in support of such transactions was prepared after the transactions had taken place. The group of offshore and domestic corporations, trusts, banks, partnerships and other entities which Margolis and those employed in his office used to implement tax planning for clients was referred to collectively as 'the system' and individually as 'system entities'. System entities were managed and controlled, either directly or indirectly, by Margolis and all financial activities in which they were involved were determined and directed by him. System entities dealt almost exclusively with clients of Margolis in the implementation of tax planning activities. To keep track of the client's tax planning activities and the attendant transactions, Margolis and his employees utilized their so-called system accounting. System accountings were primarily maintained on the cash basis and constituted a chronological history of the transactions of a client within the system. System accounting was devised to enable the Margolis office and the client to determine the client's cash position within the system at any particular time. While the format of system accounting could vary in individual situations, it normally consisted of a work sheet containing columns designating the date, transaction, investment, amount paid in (or credit), amount paid out (or debit) and the balance. There was no requirement that strict accounting rules be followed in preparing and maintaining a system accounting.
All funds flowing into the system from a client or an outside entity were entered in the system accounting as a credit while all funds flowing out of the system to a client or outside entity were entered in the system accounting as a debit. Credits were netted against debits to arrive at a balance in the system accounting. If a debit balance existed within the system as shown in the system accounting, funds flowing into the system from the client or outside entity would be used to reduce the debit balance. If a credit balance existed within the system as shown in the system accounting, funds flowing into the system from the client or outside entity increased the credit balance. Since the system accounting only reflected the client's cash position within the system, a loss from an investment in a system entity would not be reflected in the system accounting. Transactions involving transfers of money from one system entity to another system entity could take place even though there was a debit balance in the system accounting. In Margolis' use of a system accounting, transactions involving money transfers could take place without regard to what was included in the system accounting. Funds flowing into the system from a client in payment of interest on a loan obtained from a system entity were entered as a credit on the system accounting. A credit balance on a system accounting redounded to the benefit of the client in that it was available to him for future use. In order to implement his tax planning techniques Margolis or his employees engaged in so-called 'money movements.' A typical 'money movement' consisted of borrowing money from one system entity and paying it to another. A 'money movement' is described by the following pattern: periodically, after an accumulation of 'transactions requests' submitted by Margolis or his employees was collated, a series of proposed transactions was plotted on a spread sheet. An authorization form was executed for each transaction by the individual in charge of the particular 'money movement.' Such authorization forms usually indicated the amount involved in the transaction, the parties involved, whether the money was to leave the system in question and the purposes of the transaction. 'Money movements' took place approximately twelve times during a year. In carrying out a particularly complex 'money movement' it was customary to hold prior discussions with the financial institutions involved to insure the ready flow of funds. All the necessary documents in a 'money movement' were prepared in advance and if a domestic bank was involved said documents were delivered to the bank prior to the 'money movement.' Certain 'money movements' would take place at a determined time as implemented by a series of domestic and international telephone calls placed in sequential order.
The following entities, among others, were system entities: International Aesthetics, Ltd. (International Aesthetics); Associated Arts, N.V. (Associated Arts); Presentaciones Musicales, S.A. (Presentaciones Musicales); California Aesthetics, Ltd. (California Aesthetics); Maryelle Corporation (Maryelle); Antigua Banking, Ltd. (Antigua Banking); Anglo Dutch Capital Co. (Anglo Dutch); Koningsplien, N.V. (Koningsplien); World Entertainers, Ltd. (World Entertainers); Associated Convalescent Enterprises; and World Minerals, N.V. (World Minerals).
California Aesthetics was dissolved on November 10, 1977.
On November 20, 1972 petitioner's board of directors resolved to issue 20,000 shares of capital stock at $10 per share to International Aesthetics and a stock certificate (No. 1) was issued to that effect. No stock certificates had been issued by petitioner prior to that date. On February 28, 1974 petitioner's board of directors authorized the transfer of the stock held by International Aesthetics to California Aesthetics. Stock certificate (No. 1) was assigned by International Aesthetics to California Aesthetics on February 28, 1974 and on the same date petitioner issued stock certificate No. 101 to California esthetics for 20,000 shares. On November 23, 1976 stock certificate No. 101 was assigned by California Aesthetics to Presentaciones Musicales.
(3) BUYER desires to obtain the exclusive rights to all of SELLER'S processes, methods and procedures.
(3) SELLER and BUYER recognize that many of the processes, methods and procedures are intangible items existing only within the mind of SELLER. SELLER represents that he will reduce said intangible items to writing within a reasonable period of time after the execution of this Agreement. BUYER shall possess all rights incident to ownership in said processes, methods and procedures including all of those intangible items described above.
(5) SELLER guarantees BUYER that within the TEN (10) year period preceding the above-described payment to SELLER, BUYER shall realize Six Million Dollars ($6,000,000.00) in gross income by and through the proper, prudent, efficient and business-like use and development of the within-described processes, methods and procedures. BUYER represents that it shall use and develop said processes, methods and procedures in a competent business fashion and use all reasonable effort to maximize gross income from their use and development. SELLER and BUYER agree to review, at least annually the direction and policy which BUYER is undertaking in said use and development. BUYER agrees that any significant and/or other than ordinary directional and/or policy change shall be discussed with SELLER at the time of its occurrence in addition to any planned annual meetings. Should BUYER not realize said Six Million Dollars ($6,000,000.00) in gross income in the described Ten (10) year period there shall be pro rata reduction of price due and payable on October 4, 1981.
(1) EMPLOYER has simultaneously herewith obtained the exclusive rights to EMPLOYEE's processes, methods and procedures; and in addition to that acquisition would like to obtain the personal services of EMPLOYEE; and, (2) EMPLOYEE is seeking a financially satisfactory permanent arrangement which will be coupled with the sale of his processes, methods and procedures.
NOW, THEREFORE, in consideration of the mutual promises contained herein, the parties hereto agree as follows: (1) The parties recognize and acknowledge that this Agreement is being executed simultaneously with an AGREEMENT OF SALE by and between EMPLOYEE and EMPLOYER. Said AGREEMENT is marked Exhibit 'A', attached hereto and incorporated by this reference as if fully set forth herein.
(2) This Agreement shall be effective as of October 4, 1971, and shall continue until mutually rescinded by the parties hereto or until such other termination occurs under the terms and conditions as set forth herein. (3) EMPLOYER shall pay to EMPLOYEE, as salary, Two Thousand Five Hundred Dollars ($2,500.00) per month for the duration of this Agreement. Said compensation shall be reviewed and discussed annually on each October 4 or on such other date as may be mutually agreed upon by the parties hereto and said amount may be increased or decreased at any such meeting for the ensuing yearly term but shall at no single meeting be increased or decreased more than Five Hundred Dollars ($500.00) per month. Each party agrees to and guarantees a good faith participation in said annual compensation discussions. EMPLOYER may, at its sole discretion, award EMPLOYEE a bonus within the last thirty (30) days of any calendar year.
(4) EMPLOYEE shall have a reasonable opportunity to approve all services required of him by EMPLOYER and EMPLOYEE may refuse to perform any services which are not in keeping with his competence, position and personal dignity in the area of mind expansion and growth of mental awareness. EMPLOYEE recognizes that it is in the mutual interest of himself and EMPLOYER that he remain an active public figure in these areas and, therefore, he agrees that he will not unreasonably refuse to perform any services called for by the terms of such agreement. Should a dispute arise between the parties concerning the reasonableness of any EMPLOYEE refusal to perform any said services, such dispute shall be subject to binding arbitration.
(5) EMPLOYER recognizes the unusual qualities which EMPLOYEE possesses and hereby agrees that he shall be given full credit and recognition for all present processes, procedures, methods and to any further developments for which he may be responsible during a term of this Agreement and EMPLOYER further agrees that any organizations, entities or other groups which are established to promote, produce or otherwise disseminate such creations shall always give due recognition to EMPLOYEE. (6) The compensation to be paid to EMPLOYEE under this Agreement shall not include payment for his services in other than a person-to-person, face-to-face dissemination of the processes, procedures and methods and promotion thereof; and, EMPLOYEE shall receive Ten Percent (10%) of all income from publication, recording, television, motion pictures and any other related dissemination that does not involve a person-to- person, face-to-face presentation. This percentage may vary according to the terms of the contracts entered into between EMPLOYER and others (with the reasonable approval of EMPLOYEE as defined in #4 above) but shall in any Two (2) year period equal a Ten Percent (10%) return from all such income in any of the above-described areas.
(7) EMPLOYEE agrees that he will perform his services exclusively for EMPLOYER. (8) EMPLOYER agrees to pay EMPLOYEE either directly or by way of reimbursement, all medical, dental and hospital bills incurred by EMPLOYEE himself, or by his wife or by those of his children who qualify as dependents under Sections [sic] 152 of the Internal Revenue Code of 1954.
(9) EMPLOYER shall provide EMPLOYEE during the employment term with the use of an automobile whose total price shall not exceed Twelve Thousand Dollars ($12,00.00) with optional equipment at EMPLOYEE's selection. EMPLOYER agrees to pay all operating expenses of any nature whatsoever with regard to such automobile and to procure and maintain in force an automobile liability insurance policy on such automobile, with coverage including EMPLOYEE. EMPLOYER in its sole discretion may designate that EMPLOYEE be the registered owner of the automobile and/or the policy of insurance be in the name of EMPLOYEE. (10) EMPLOYER requires EMPLOYEE to maintain a private office with stenographic help, office equipment, supplies and such other facilities and services that are equitable to his position and adequate for the performance of his duties. EMPLOYER shall pay all expenses, including rent and property taxes if required, incurred in such private office. (11) EMPLOYEE is authorized to incur reasonable business expenses for promoting, including expenditures for entertainment, gifts and travel. EMPLOYER will reimburse or pay directly EMPLOYEE's expenses in those areas provided only that EMPLOYEE presents to EMPLOYER reasonable documentary or other evidence of such expenditures.
(12) All business expenses as described herein reasonably incurred by EMPLOYEE in promoting the business of EMPLOYER, including expenditures for entertainment, gifts and travel, are to be paid for, insofar as this is possible, by the use of credit cards in the name of EMPLOYER. EMPLOYER will furnish such cards to EMPLOYEE as EMPLOYER in its discretion deems necessary for EMPLOYEE's use.
(13) EMPLOYER agrees to provide to EMPLOYEE a Four Hundred Twenty-Five Thousand Dollar ($425,000.00) loan at a Four Percent (4%) interest rate for a term of Five (5) years. EMPLOYEE must request said loan be made within Five (5) years of the execution of this Agreement or EMPLOYER is no longer bound to make such loan.
(14) EMPLOYER recognized [sic] that EMPLOYEE's public appearance will have a direct bearing upon his performance in his presentations of processes and methods and thereby agrees that it shall provide a monthly clothing budget of Five Hundred Dollars ($500.00). Such clothes as purchased by EMPLOYER shall remain the property of EMPLOYER and EMPLOYEE shall be responsible for all but reasonable wear and tear on such clothes. EMPLOYER guarantees an initial wardrobe allowance, in addition to the above monthly allowance, of Five Thousand Dollars ($5,000.00). Said sum shall be payable within Two (2) years from date of this Agreement.
(15) The office which EMPLOYER agrees to maintain for EMPLOYEE shall contain sleeping quarters and it is presently contemplated that it may be a home in San Francisco. It is expected and agreed that expenses for such office might run as high as One Thousand Dollars ($1,000.00) per month. EMPLOYER agrees to assume those expenses provided they do not exceed an average of One Thousand Dollars ($1,000.00) per month for any One (1) year period. Should expenses exceed One Thousand Dollars ($1,000.00) per month for any One (1) year period, EMPLOYEE shall be liable and shall pay the difference.
(16) EMPLOYER agrees that it will provide to EMPLOYEE any and all expenses and membership dues or any other related expenses in professional organizations which will further his experience, knowledge and public exposure in the area of mind expansion and development. These expenses shall extend to social as well as business clubs, organizations and associations.
(22) EMPLOYEE will at all times cooperate fully with EMPLOYER in seeking and obtaining employment opportunities. Should EMPLOYEE become aware of possible employment opportunities, he shall bring them to the prompt attention of EMPLOYER. EMPLOYEE agrees he shall cooperate fully with EMPLOYER and make all attempts to arrange for his employment when such opportunities arise. (23) From and after this date, EMPLOYEE shall not enter into any other agreement of any kind with reference to employment or services described herein without prior notice to EMPLOYER, its successors or assigns, for the duration of this Agreement. If such employment or services are to be undertaken by EMPLOYEE during a time in which he is not under the exclusive control of EMPLOYER, EMPLOYER must give its written consent prior to EMPLOYEE's agreement to engage in such services. However, EMPLOYER agrees it shall not unreasonably withhold its consent, if the terms of the performance of such services are within the provisions of this Agreement.
(24) EMPLOYEE shall make himself available from time to time for necessary promotional activities at the request of EMPLOYER and at the sole expense of EMPLOYER, provided only that time spent in such promotional or publicity activities shall be charged against the total time required by EMPLOYEE on this agreement.
(25) EMPLOYEE agrees to execute at any time any and all documents of any kind and nature whatsoever which EMPLOYER may request in order to confirm and enforce the rights of EMPLOYER to the processes, methods and presentations as more specifically defined herein as they had been transferred to EMPLOYER.
(26) No amendment or variation of the terms of this Agreement shall be valid unless made in writing and signed by the EMPLOYEE and the fully authorized representative of the corporation.
(27) A waiver of any of the terms and conditions contained in this Agreement shall not be construed as a general waiver by the waiving party, and the waiving party shall be free to reinstate said part or clause, so long as the other party receives due notice of the reinstatement. Said notice may be either oral or in writing.
(28) This Agreement shall be binding upon the successors, heirs, executors, administrators, and assigns of the parties hereto. IN WITNESS WHEREOF, the parties hereto set their hands and seals the day and year first above written.
(3) LICENSEE wishes to obtain a Ten (10) year right to be the exclusive United States distributor of the processes, methods and procedures as well as ERHARD's personal presentations thereof.
LICENSOR hereby grants to LICENSEE an exclusive Ten (10) year license to all and everything LICENSOR possesses pursuant to that certain Agreement of Sale entered into on the Fourth day of October, 1971, by and between ERHARD and LICENSOR. A copy of such agreement is marked Exhibit 'A', attached hereto and incorporated by this reference as is fully set forth herein. Said license rights shall be limited to presentations to be made in the United States unless specific written permission is obtained from LICENSOR for foreign presentations. The term United States shall include the Continental United States, Alaska, Hawaii and any other possessions or territories of the United States of America.
LICENSEE hereby specifically assumes all obligations of LICENSOR to ERHARD as such obligations are contained in an employment contract between LICENSOR and ERHARD. A copy of such contract is marked Exhibit 'B' and incorporated by this reference as if fully set forth herein.
LICENSEE shall have the option to extend this Agreement for Five (5) additional years provided that One (1) year's written notice be given to LICENSOR. Within Thirty (30) days of the exercise of the option, LICENSEE shall pay to LICENSOR an additional Six Hundred Thousand Dollars ($600,000.00).
This Agreement shall be binding upon the successors, heirs, executors, administrators, and assigns of the parties hereto. IN WITNESS WHEREOF, the parties hereto set their hands and seals the day and year first above written.
RESOLVED FURTHER, that under the terms of such PMSA-Erhard agreement for personal services, there is subject to the approval of Erhard, the acceptance of any employment which PMSA by license or otherwise may provide for said Erhard. It is therefore understood that said officer is hereby as president directed to execute on behalf of and as the person rendering services under said contract, such authorization or approval as he in his absolute discretion deems fit, with the complete approval of this corporation, as evidenced by the signature of its secretary-treasurer, who is hereby authorized to make such authorization.
On December 14, 1971 petitioner's board of directors authorized Erhard (as chairman of the board) and Scheaf, as president, to borrow $1,000,000 from International Aesthetics, a Nevada corporation, and as security for said loan to 'execute documents conveying the copyrighted copies of the body of knowledge in a form to be agreed upon by said officers in the corporation.' A resolution adopted by petitioner's board of directors indicates that Erhard and Scheaf were not elected as petitioner's chairman of the board and president, respectively, until June 23, 1972.
On December 14, 1971 Joel Kahan, as president of International Aesthetics, executed a promissory note in favor of Associated Arts (Curacao, Netherlands Antilles) in the amount of $6,911,835. On December 15, 1971 International Aesthetics (14612 Big Basin Way, Saratoga, California) opened a checking account in the Union Bank (Wilshire Center, regional head office, Los Angeles) with a deposit of $7,000,000. On the same date the account was charged with the following amounts: $800,000 paid to World Entertainers, $5,000,000 paid to Koningsplien; and $1,200,000 paid to an unidentified payee.
For value received International Aesthetics, Limited hereby sets over, conveys, assigns and transfers the within promissory note to Presentaciones Musicales, S.A., a Panamanian corporation, without warranty. Interest has been paid on said promissory note through February 28, 1974, and principal has been paid in the amount of $90,000.
effective February 28, 1974, with interest paid through the effective date. This transfer is made with recourse.
World Entertainers Limited hereby assigns and sets over t o Antigua Banking Limited all of the right, title and interest o f World Entertainers Limited in and to the within obligation, effective to 1st day of March, 1974 with interest paid through the month of February, 1974. This assignment, is made with recourse.
In addition to the promissory note described above, Erhard, representing petitioner, also executed a promissory note form, denominated Note No. 1 and dated December 14, 1971, which stated that petitioner promised to pay $1,000,000 to International Aesthetics one year after date payable monthly at the rate of 10 percent per annum from December 14, 1971. In a letter dated December 14, 1971, Scheaf, representing petitioner, authorized the Union Bank (Wilshire Blvd. at Western, Los Angeles) to transfer $1,200,000 to Presentaciones Musicales. On December 20, 1971 petitioner opened a checking account in the Union Bank (San Jose Regional Office, San Jose) with a deposit of $1,200,000 and a withdrawal of this same amount was made on the same day. An 'account charge' issued by the Union Bank shows that an amount of $1,200,000 was withdrawn from this account and remitted to a bank account of Presentaciones Musicales in Curacao, Netherlands Antilles on December 15, 1971. International Aesthetics issued three checks signed by Joel Kahan to petitioner dated September 9, 1971 in the amounts of $100, $100 and $10,000. Erhard, representing petitioner, executed a promissory note (Note No. 2) dated October 1, 1971 to International Aesthetics in the amount of $10,200. This transaction was recorded in petitioner's General Journal on January 31, 1972. On August 31, 1972 Erhard executed a promissory note in favor of International Aesthetics in the amount of $425,000. Erhard did not solicit this loan from International Aesthetics but, instead, discussed his need for a loan with someone in the Margolis office. Petitioner's books and records reflected payments designated as interest payments on the loans obtained from International Aesthetics.
During the years 1971-1975 Erhard made presentations on behalf of petitioner outside the United States. He did not obtain written permission from Presentaciones Musicales to make said presentations.
This Agreement is entered into this 9th day of August, 1973, by and between ERHARD SEMINARS TRAINING, a California corporation, and PRESENTACIONES MUSICALES, S.A., a Panamanian corporation, hereafter respectively referred to as EST and PMSA.
1. This Agreement refers and relates to the State of Hawaii, U.S.A., only. The parties hereby rescind and cancel the License granted and agreed upon in the agreement attached hereto as Exhibit 'A' as it relates to the State of Hawaii.
2. Said License rescission and cancellation shall become effective immediately. EST will cease to transact any and all business in the State of Hawaii except for necessary closeout thereof.
12. PMSA and EST share the goal that License shall at all times in its procedures, methods, processes and promotion be a thoughtful, constructive and useful public service. PMSA intends at all times to reserve to itself ultimate control of License for the sole purpose of accomplishing this goal. EST agrees that it will adopt a similar program with reference to its personnel with the same goal in mind. EST will, on request from PMSA or any of its Licensees, review advertising and promotional material as well as collateral services and activities, to insure that the goal is kept in mind at all times in all areas. PMSA will compensate EST for any unusual services of this kind.
13. PMSA will not enter into any independent contractual relationship with any employee of EST without the prior written approval of EST for the period of this Agreement, provided only that EST shall be performing satisfactorily under this Agreement.
14. EST does intend to and will make available to PMSA the rights for various areas controlled by EST with reference to License as requested by PMSA. Reasonable compensation shall be paid for any such modification of the license rights held by EST. EST shall have the opportunity to supply trainers and all other services relating to License for any such local area relinquished by EST to PMSA.
15. The Agreement of December 4, 1971, shall continue unchanged as between the parties except as expressly modified herein.
IN WITNESS THEREOF, the parties have set their hands and seals the day and year first above written.
Commencing with the December 4, 1971 License Agreement petitioner amortized the cost of the license at the rate of $10,000 per month through August 31, 1975. Petitioner did not reduce the asset value of the license on its books to reflect the August 9, 1973 agreement with Presentaciones Musicales for the partial repurchase of exclusive license rights by Presentaciones Musicales. Nor did petitioner reduce the monthly amortization of $10,000 which petitioner had previously been claiming as a deduction with respect to the license. Petitioner claimed amortization deductions with respect to the license through August 31, 1975 in the total amount of $440,000, leaving an unamortized amount as of that date of $760,000. Petitioner then reclassified the unamortized balance as an account receivable from Presentaciones Musicales. As of December 1976 no effort had been made by petitioner to collect this unamortized amount. Respondent disallowed the amortization deductions claimed by petitioner in each of the taxable years ended April 30, 1972 through 1976.
On or about September 1, 1975 est, An Educational Corporation was formed with Don Cox as president and Scheaf as secretary. It is stipulated that the tax consequences of the transfer of any assets and liabilities from petitioner to est, An Educational Corporation, are not in dispute. For the most part the management and employees of petitioner continued with est, An Educational Corporation which also took over substantially all of petitioner's training facilities throughout the United States. The newly formed corporation continued to give the standard training formerly given by petitioner and also continued the communication workshops, relationships programs, graduate reviews, childrens' programs and prison trainings formerly conducted by petitioner. Petitioner ceased its various business activities (including the standard training) and, upon changing its name to Twine late in 1975, it did not retain any of the EST employees or officers. Margolis became president of Twine.
2. The employment arrangements under which the services of ERHARD were made available to PMSA for a period of years led to the direct employment of ERHARD by Erhard Seminars Training, a California corporation. Such arrangements are terminated effective 1 September 1975. Erhard Seminars Training, hereinafter referred to as Twine, will execute a copy of this Agreement to confirm its acquiescence in the termination of its employment relationship with ERHARD.
3. The circumstances existing on [sic] October of 1971 have changed dramatically. The parties then contemplated a relatively small and slowly growing educational program. Neither party anticipated the manner in which the Body of Knowledge would explode in terms of public acceptance. It is now clear that the responsible dissemination of the Body of Knowledge as rapidly as possible everywhere must take priority over any other purposes to be served. ERHARD has moved forward to make it possible for the Body of Knowledge to be controlled for the United States of America by an educational trust located in the British Commonwealth and for the rest of the world by an educational foundation established in Switzerland. 4. PMSA has reacquired all of the rights to the Body of Knowledge which it had at any time. It has disposed o such rights effective 1 September 1975 to Welbehagan B.V. PMSA warrants it has or will have responsibly compensated all those individuals or entities which have had, directly, or indirectly, an interest in the Body of Knowledge prior to 1 September 1975. ERHARD has no responsibility for such compensation.
6. ERHARD accepts full responsibility for the future of the Body of Knowledge. This includes future growth, responsibility for scientific research and legal design and structure. ERHARD shall hold PMSA harmless in all respects with reference thereto. 7. The parties intend that PMSA, directly and in a representative capacity, shall be fully and fairly compensated for the services it has rendered to ERHARD and the Body of Knowledge. PMSA has accepted as reasonable a proposal from Welbehagen, B.V. for final disposition by PMSA of its rights to the Body of Knowledge. PMSA has agreed that any difficulty as to compensation will be submitted to arbitration in London and application will be made to an appropriate London Court if there are any procedural problems.
a. ERHARD, as the source of the Body of Knowledge, was and continues to be indispensable to its presentation and development. For the present, the comfortable responsible availability of ERHARD together with the Body of Knowledge is essential if this Agreement and its purpose is to be meaningful. ERHARD has therefore advised PMSA and the various entities having any relationship with the Body of Knowledge as a result hereof that ERHARD will continue on a reasonable basis to accompany and be part of the Body of Knowledge for the indefinite future. To that end, ERHARD has negotiated with est, U.S.A., an Employment Agreement making the services of ERHARD available to carry out the purposes intended by the parties.
c. The guarantees made by ERHARD to PMSA in the Agreement of Sale have not been realized. The parties acted responsibly at all times and neither was at any time in the wrong. There was no default or neglect by ERHARD at any time. There is little doubt but what the guarantees would have been achieved over the total period of the Agreement of Sale. The guarantees of ERHARD are cancelled effective with the execution of this Agreement.
e. The specific references in this paragraph are part of the total agreement and are not intended to exclude any items omitted and are rather extensions of the Agreements reached between the parties.
10. Financial obligations between the parties have been fulfilled by the parties. The Four Hundred and Twenty-Five Thousand Dollar ($425,000.00) loan to ERHARD was made by PMSA under Paragraph 13 of the Employment Contract. This item continues to exist independent of this Agreement.
This agreement is entered into by and between PRESENTACIONES MUSICALES, S.A., a Panamanian corporation, hereinafter referred to as 'PMSA,' and WELBEHAGEN INTERNATIONAL, a Netherlands corporation, hereinafter referred to as WELBEHAGEN, to be effective September 1, 1975.
a. It is a Panamanian corporation validly existing under Panamanian law, with address at P.0. Box 7292, Panama 5, Republic of Panama.
b. It has power and authority to enter into this agreement and is the owner of the rights to the est Body of Knowledge which is the subject of this agreement.
c. It originally acquired rights pursuant to an agreement of sale and an employment contract dated October 4, 1971, and a termination agreement effective September 1, 1975, the parties to which were PMSA and Werner Erhard, all of which documents have been made available to WELBEHAGEN.
a. It is a Netherlands corporation validly existing under Netherlands law and has full power and authority to enter into this agreement. Its address is Bleuhandweg 450, Gouda, the Netherlands.
b. All action taken by WELBEHAGEN under this agreement or as a consequence thereof will be defended by WELBEHAGEN as to any attack thereon.
3. PMSA will, at its own cost and expense, defend and perfect all aspects of clear and unencumbered title and the right to utilize est throughout the world at any time, and under any circumstances upon reasonable notice from WELBEHAGEN. PMSA will do or cause to be done all things necessary to complete the transfer of all rights (est) to WELBEHAGEN. It is the intent of the parties that there will be supplied to WELBEHAGEN a complete listing and directory of all of the est material, whether or not subject to copyright, trademark or trade name registration. Any est material that may have been registered in the name of someone other than Werner Erhard or PMSA will be placed in a form satisfactory to WELBEHAGEN, at the sole cost and expense of PMSA, on request. It is the understanding of the parties that registration in the name of Werner Erhard is generally the agreed procedure with reference to registration.
Erhard Seminars Training, Inc., was at all times a trustee and licensee with reference to est.
4. The parties intend that the Book of Aphorisms, copyrighted by Werner Erhard in 1973, shall be included as part of est. 5. PMSA hereby assigns, sets over and sells to WELBEHAGEN all of PMSA's right, title and interest in and to est. The parties recognize that the value of est must at all times be considered speculative. To this date, the exploitation of est in an economic sense has been largely limited to the United States of America. All economic data with respect to such activities of Erhard Seminars Training, Inc., have been made available to WELBEHAGEN and are warranted by PMSA to be true and correct in all respects.
6. The purchase price for all of the assets conveyed hereunder by PMSA to WELBEHAGEN is fifteen million dollars ($15,000,000) (U.S.). Said sum shall be payable by WELBEHAGEN to PMSA in installments of no less than one million dollars ($1,000,000) (U.S.) per year. Each annual installment shall consist of interest at the rate of nine percent (9%) on such sum as shall represent the principal value of licenses disposed of or directly operated by WELBEHAGEN from time to time. No interest shall be paid on any sum in excess of such principal value. WELBEHAGEN may prepay all principal at any time at its own convenience and without the consent of PMSA. So much of any payment as shall not be required for interest shall be attributed to principal. The total of interest actually due shall be the minimum payment to be made by WELBEHAGEN to PMSA for the first four years under this agreement. Commencing with the fifth year, WELBEHAGEN must pay to PMSA at least one million dollars ($1,000,000) (U.S.) a year on account of principal while keeping all interest current.
7. The sole security for the performance required of WELBEHAGEN in terms of payments to PMSA hereunder shall be est. PMSA shall be limited to recovering from WELBEHAGEN sums actually accrued and due and unpaid up to any moment at which PMSA reclaims est.
10. PMSA acknowledges that it has no direct or indirect claim to the copyrighting of est and that it will cooperate with WELBEHAGEN and Werner Erhard in every respect as to any and all matters relating to ownership or copyright or trademark or whatever else may be required of it.
11. PMSA specifically assigns and sets over to WELBEHAGEN any right, title and/or interest PMSA may have in and to the trademark 'est' for which an application is pending in the Patent and Trademark Office of the United States of America. The same is true as to any other trademark or copyright of any kind, however held.
14. Neither party hereto shall assign rights or obligations hereunder to any person or entity without the express written approval of the other party. Approval of assignment shall not be unreasonable [sic] withheld, and any assignee shall expressly assume full liability while not releasing the party having made the assignment, which party shall continue to remain liable.
IN WITNESS WHEREOF, the parties have executed this agreement the day and year set opposite their names, to be effective the first day of September, 1975.
3. The office of Fursprecher Wolfgang von Erlach in Zurich, Switzerland, has undertaken the establishment of a public tax-exempt foundation to be known as 'The Werner Erhard Foundation for est'. It is the purpose of said Foundation to engage in educational charitable activities arising out of the est Body of Knowledge. Welbehagen will in due course be owned by a Swiss corporation which will be donated to two Foundations.
4. It has the exclusive right to grant the License which is the subject of this Agreement, limited only as set forth herein. 5. It is contracting herein to carry out the express purposes of Werner Erhard in that it will at all times proceed from responsibility for the broadest possible communication of the Body of Knowledge, as defined below.
6. Its address is Bleulandweg 450, Gouda, the Netherlands.
3. It is solely owned by an educational charitable trust created by Werner Erhard in Jersey, Channel Islands.
4. It is contracting herein to carry out the express purposes of Werner Erhard in that it will at all times proceed from responsibility for the broadest possible communication of the Body of Knowledge, as defined below.
a. 'Body of Knowledge' includes all of the est material of which Werner Erhard is the source. Such material is reflected in all of the activities of Erhard Seminars Training, a California corporation, which controlled est material from 1971 to August 31, 1975. The Body of Knowledge involves educational materials and methods. These are directed toward the recognition and realization of the ability of each individual to understand his or her experience, to develop a degree of consciousness that will permit better communication and make more meaningful life and living for each individual. The Body of Knowledge further includes ongoing study and research, written and oral, into the development of processes, lectures, trainings, workshops and [FNo] seminars.
b. 'Copyright' is used herein as defined by the Uniform Copyright Convention.
c. 'The Training' is the est Standard Training as it is presently given in the United States of America. Its basic format at present involves the individual trainee in a two- weekend course with a pre-, mid- and post training included therein. d. 'Reserved rights' are licenses for any area outside of the United States of America as defined herein.
e. 'Trademark', as used in this License, refers to the definition of trademark adopted by the particular relevant country. f. 'Trainee' refers to the individual participating as a student in the Training.
g. 'Trainer' is an individual giving The Training who is trained and employed by an entity licensed by Welbehagen to give The Training.
h. 'U.S.' represents the United States of America, its territories and possessions. Included also are any United States military bases where the individuals on such military bases, who receive any benefit out of any provisions relating to this License, are United States military personnel or their immediate families.
The Term of this License is for a period of ten (10) years beginning September l, 1975, and ending August 31, 1985.
WELBEHAGEN, for the considerations stated herein, conveys to est an exclusive license to the Body of Knowledge for the U.S.
a. Pay WELBEHAGEN Ten Million Dollars ($10,000,000) (U.S. funds), on or before August 31, 1985. Any unpaid balance shall bear interest at the rate of ten percent (10%) per annum. est may pay WELBEHAGEN interest only for a period not to exceed three (3) years. Thereafter est shall pay WELBEHAGEN no less than One Million Dollars ($1,000,000) (U.S. funds) each year on account of principal while keeping interest current for each year thereafter, with the full balance of principal and interest being due on the last of the term. est shall have the right to prepay any or all of the amount due at any time during the life of this Agreement.
b. The Body of Knowledge, specifically including all new material developed during the life of this license, shall at all times be the property of WELBEHAGEN, est's interest therein shall be that of a license only.
c. est shall make Werner Erhard available to WELBEHAGEN at any and all times, provided only that all costs (salary, travel, etc.) shall be paid by WELBEHAGEN and that such availability is reasonable under this agreement. WELBEHAGEN must make its own independent arrangements with Werner Erhard.
est shall at all times support, protect and present the Body of Knowledge in a manner consonant with the standards characterizing its presentation to the public to date. est shall at all times meet the current standards as established for the Standard Training, Graduate Seminars, Guest Seminars, Workshops and Special Events. est shall not modify the present program in any substantial detail without the prior written approval of WELBEHAGEN.
This is a License, and WELBEHAGEN does not retain any direct or indirect control of est. est shall, however, adopt and maintain employment policies which are responsible and which convey to the general public the sense of integrity that is consistent with the Body of Knowledge.
WELBEHAGEN reserves all rights to the Body of Knowledge for all areas other than those specifically licensed to est hereunder.
WELBEHAGEN will consult with est and/or offer est the right of first refusal wherever there is a potential of direct competition in terms of geographic location or population between the reserved area contemplated to be licensed by WELBEHAGEN and the area in which est is licensed.
It is contemplated that the parties shall be free to develop the Body of Knowledge in all respects. The parties shall communicate on a regular basis conveying the information as to development programs. WELBEHAGEN will communicate to est all information or material which comes to its attention which relates to the Body of Knowledge. The parties shall consider exchanging personnel when convenient from time to time. All programs or material developed by est as the Licensee shall become the property of WELBEHAGEN. est shall have the right to utilize all such program or material without additional charge under this Agreement and without any additional charge for any extended period of this Agreement with reference to the programs or materials developed by est or WELBEHAGEN. WELBEHAGEN shall in any case compensate est for its costs in this area. In return, WELBEHAGEN shall have the right to immediately utilize programs and materials developed by est wherever WELBEHAGEN wishes without additional compensation to est.
The parties acknowledge the value of the contribution of Werner Erhard to est and acknowledge that they will follow the advice of Werner Erhard with reference to implementation of new programs or material in the Body of Knowledge in the U.S. Should Werner Erhard not be available, WELBEHAGEN will suggest changes to est with reference to new programs or material during the life of this Agreement. est shall not be required to follow the suggestions of WELBEHAGEN under such circumstances.
est shall have the right to publish and/or distribute any printed material in any form in the U.S. without prior approval of WELBEHAGEN, provided only that such publication or distribution is consistent with the integrity of the Body of Knowledge. Periodic reports concerning such material or publications shall be made available to WELBEHAGEN, and WELBEHAGEN will do the same for est with regard to material and publications from other license or by WELBEHAGEN itself.
Publication or distribution by est of printed material in areas other than the U.S. shall require the prior written approval of WELBEHAGEN. Such approval will not be unreasonable [sic] withheld. Participation in the expenses and profits in areas outside of the U.S. on a reciprocal basis shall be the subject of further mutual Agreement between WELBEHAGEN and est and/or other Licensees.
est acknowledges that WELBEHAGEN and Werner Erhard own and control whatever rights exist to the Body of Knowledge resulting from copyright of all or any portion thereof.
The parties acknowledge that the Body of Knowledge material has been copyrighted to date in the name of Werner Erhard and in the name of the entity holding current licensing rights to the Body of Knowledge on other occasions. There have been on occasion some errors in copyright by a licensee which should have been in the name of Werner Erhard. est will accept the responsibility for technical correction of any such errors occurring in the past, provided all costs shall be the responsibility of WELBEHAGEN.
est shall copyright and/or renew copyright of any material containing the creative input of the Body of Knowledge in a timely fashion in the name of Werner Erhard or WELBEHAGEN only. WELBEHAGEN or Werner Erhard may so act on their own. The parties shall communicate and cooperate for their mutual convenience in this regard. All costs shall be paid by WELBEHAGEN.
WELBEHAGEN shall seek trademark registration for 'est' together with any service marks which may be appropriate in areas other than the U.S. at its own discretion. est shall register service marks in the U.S. as soon as it is possible to register them.
The parties acknowledge that the continued integrity and form and substance of the Body of Knowledge is of fundamental importance. Form or substantive changes of serious import shall be the subject of prior communication between the parties. est shall as Licensee have ultimate discretion within the U.S. and shall give every thoughtful consideration to the views of WELBEHAGEN on all occasions.
Werner Erhard has been requested to indicate his understanding and approval of this Agreement by becoming a signatory thereto.
In no case shall the signature of Werner Erhard be interpreted as making him a party to this Agreement.
This Agreement is entered into by and between Presentaciones Musicales, S.A., a Panamanian corporation, hereinafter referred to as PMSA, and Twine, Inc. (formerly Erhard Seminars Training, Incorporated), a California corporation hereinafter referred to as Twine, and Werner Erhard, an individual, hereinafter referred to as Erhard.
WHEREAS, the parties hereto agree that it was their understanding, and they ratify and approve any acts consistent with this understanding, that the Standard Training should be copyrighted in the name of Werner Erhard alone.
This letter is written to confirm my termination agreement with Presentaciones Musicales, S.A. I did recover the ultimate ownership of the est Body of Knowledge and did so under circumstances which permitted PMSA to make a one-time disposition of est to an entity of my choice or recommendation provided that such entity was ultimately owned and operated for the benefit of the public. Welbehagen, B.V. qualifies.
This is, therefore, to confirm to and for you the authority of PMSA to enter into the agreement with you. I have expressly advised PMSA and now advise you that I do not wish to participate in any negotiations nor to have any knowledge of negotiations and I do so on advice of counsel so that there will be no question of the independence of your action. I seek only to have PMSA properly compensated and fully removed from any relationship to est so that there will be no question that est belongs to the world from this point forward.
Erhard made variations in the presentation of the est standard training since its inception without seeking approval for such changes. At the time of the trial of these consolidated cases in 1983, Erhard was self-employed under the name Werner Erhard and Associates, conducting various programs with major emphasis on the est standard training. Other programs included seminars on communications, integrity, relationships, language, business management and organizational development.
Please accept this letter as authorization to hold the property more specifically described in that certain Holding Agreement dated the 30th day of March, 1973 by and between Continental Title Company, first party, and Erhard Seminars Training, second party, for the benefit of The Maryelle Corporation. The undersigned has authority to and hereby does transfer said Holding Agreement to The Maryelle Corporation, and it is the purpose of this letter to provide you with authority to take instructions from this day forward as to said property from proper representatives of The Maryelle Corporation.
Under a 'Holding Agreement' dated March 30, 1973 and executed by petitioner and Maryelle Corporation (represented by Michael G. Chatzky, president, and Lois Richmond, secretary) petitioner leased Franklin House from Maryelle Corporation for a 10-year Term at a monthly rental of $3,750. By letter to Continental Title Company dated March 1, 1974 Maryelle Corporation (represented by Michael G. Chatzky, president) authorized the title company to hold the Franklin House property under the Holding Agreement for the benefit of Associated Convalescent Enterprises. By letter dated March 25, 1974 Associated Convalescent Enterprises (represented by Michael G. Chatzky, president) notified petitioner of an increased monthly rental for the Franklin House and by 'Modification of Lease' dated April 1, 1974 the monthly rental was increased to $5,000. Payments denominated as rent in the amount of $3,750 a month were made by petitioner to Maryelle Corporation from April 1, 1973 through March 30, 1974. Monthly rental payments of $5,000 were made by petitioner to Associated Convalescent Enterprises from April 1, 1974 through April 30, 1975.
In a letter dated March 22, 1977 from Margolis (in the capacity of trustee in liquidation of Associated Convalescent Enterprises), Continental Title Company was notified that Associated Convalescent Enterprises had disposed of its interest in the Franklin House property to est, an educational corporation effective February 1, 1977. In a 'Leasehold Agreement' effective June 1, 1981 est, an educational corporation leased the Franklin House property to Erhard doing business as Werner Erhard and Associates for a term of 30 years at a monthly rental of $5,000. On July 1, 1981, Werner Erhard exercised an option to purchase the Franklin House property from est, an educational corporation.
By an 'AGREEMENT' dated December 4, 1973 petitioner (represented by Scheaf, president) granted Antigua Banking Limited (represented by Margolis, president) an open line of credit in the amount of $1,000,000.
An entry posted on December 31, 1976 to the Loans Receivable account in petitioner's general ledger reflects a loan receivable from Antigua Banking Limited in the amount of $1,040,000. A journal entry (No. 24) dated March 31, 1977 in petitioner's books reflects an offset of loans payable to Antigua Banking Limited in the amount of $820,000 (plus interest) with loans receivable from Antigua Banking Limited in the amount of $833,688 (plus interest). As of May l, 1977 Antigua Banking Limited owed petitioner the amount of $848,704.
During the taxable year ended April 30, 1974 petitioner made payments for medical expenses to or for the benefit of Erhard and his wife, Ellen (hereinafter Ellen), in the amount of $1,466. Petitioner incurred expenses of $11,116, $14,558, $22,038 and $17,831 in the taxable years ended April 30, 1973 through 1976, respectively, primarily for Erhard's wardrobe. Laundry and dry cleaning expenses in the amount of $4,426 were also incurred by petitioner in the taxable year ended April 30, 1975 primarily for Erhard's wardrobe.
On occasion during the period here relevant petitioner provided meals at the Franklin House for its employees and for members of its volunteer advisory board. Petitioner also conducted special training classes, which included a 'wilderness component,' for teenagers. The fee for such programs included the cost of meals. Petitioner also conducted training sessions for children between the ages of 6 and 12. Meals were provided by petitioner during these sessions.
On its return for the taxable year ended April 30, 1975 petitioner deducted food and beverage expenses in the amount of $24,503 which was disallowed by respondent. Respondent now concedes that $17,967 is deductible. The remaining $6,536 represents one-half of the deduction of $13,072 claimed by petitioner for food and beverage expenses pertaining to the office of Werner Erhard, a division of petitioner's organization. On its return for the taxable year ended April 30, 1976 petitioner deducted food and beverage expenses in the total amount of $28,457, with $19,257 of this amount claimed under cost of goods sold and $9,200 claimed under other deductions. Respondent disallowed these deductions in full.
It was the policy of petitioner to reimburse employees who were required to submit an accounting of the expenses (including automobile expenses) incurred by them. On its return for the taxable year ended April 30, 1976 petitioner claimed a deduction for automobile expenses in the amount of $8,558 which respondent disallowed in full.
In 1973 Erhard and his administrative assistant, Charles Ingrasci (hereinafter Ingrasci), traveled to India. The entire trip lasted three or four weeks, with a few days spent in Hawaii. One of the purposes for the trip to India was to obtain material for lectures and to continue the development of the work carried on by petitioner. Erhard and Ingrasci met with religious and educational leaders in India. Some of the gifts purchased in India were given to various individuals in India and some of the gifts were given to members of the EST organization and other individuals associated with the EST organization. Among the purchases made on the trip were clothing and other personal items (i.e., camera equipment) as well as gifts and various art objects. Petitioner claimed a deduction for travel and entertainment on its return for the taxable year ended April 30, 1973 in the amount of $106,655 which included $2,594 with respect to the trip to India and $4,794 with respect to two around- the-world airline tickets for Erhard and Ingrasci. Respondent disallowed the deduction claimed for the trip to India and the world trip. Petitioner also claimed a deduction for gift and entertainment expenses on its return for the taxable year ended April 30, 1973 in the amount of $33,987. It is stipulated that, of this total, '$1,447.13 pertained to gifts, and $5,793.68 pertained to a trip to India by Werner Erhard.' The stipulated amounts were disallowed by respondent.
WHEREAS, it is deemed necessary to have preliminary arrangements made for said speaking engagements and meetings, RESOLVED, that Ellen Erhard be sent to London, England; Paris, France; Rome, Italy and Lindau and Munich, Germany to make arrangements for Werner's trip.
Ellen accompanied her husband on a trip to various European cities at some time during petitioner's taxable year ended April 30, 1974. The purpose of the trip was to give lectures, establish business relationships, obtain endorsements and explain the work of est. Petitioner claimed a deduction for travel and entertainment expenses on its return for the taxable year ended April 30, 1974 in the amount of $136,432, which amount included expenses of Ellen in the amount of $4,868.39. Respondent disallowed one-half of the deduction claimed for Ellen's expenses.
In 1971 Erhard, then an instructor for Mind Dynamics, decided to pursue a new activity including certain concepts which he originated and which are described herein as the Body of Knowledge. [FN3] He consulted with Margolis, an attorney, and other members of the Margolis law office and it was decided to use an existing shell corporation (Saratoga) for the new enterprise. On October 4, 1971 the corporation resolved to do business under the name of Erhard Seminars Training (petitioner). [FN4] On the same date Erhard executed an 'Agreement of Sale' which recited the sale of certain 'processes, methods and procedures' to Presentaciones Musicales, a Panamanian corporation, for $1,000,000 and on the same date executed an 'Employment Agreement' with Presentaciones Musicales. [FN5] On December 4, 1971, petitioner and Presentaciones Musicales executed a 'License Agreement' which recited that Presentaciones Musicales granted to petitioner an exclusive 10-year license in the United States for the above 'processes, methods and procedures' for $1,200,000. Petitioner claimed amortization deductions in each of the taxable years ended April 30, 1972 through 1976 with respect to the license in the respective amounts of $40,000, $120,000, $120,000, $120,000 and $40,000. Respondent disallowed the deduction in full.
Respondent contends that the purported sale of the Body of Knowledge by Erhard in 1971 to Presentaciones Musicales and the subsequent 10-year license from Presentaciones Musicales to petitioner (as well as the subsequent partial repurchase of the license by Presentaciones Musicales in 1973, the resale of the Body of Knowledge in 1975 by Presentaciones Musicales to a Netherlands Corporation and the subsequent peregrinations of the Body of Knowledge) were sham transactions which must be disregarded for tax purposes. It is an established principle that for tax purposes the substance of a transaction controls over its form, Gregory v. Helvering, 293 U.S. 465 (1935), and that where the sole purpose of a transaction is to obtain tax deductions, it will not be given effect for tax purposes. Knetsch v. United States, 364 U.S. 361 (1960). While a taxpayer has the right to minimize his taxes by whatever means the law permits, this right does not bestow upon the taxpayer the right to structure paper arrangements that do not stand on the solid foundation of economic reality. Cf. Zmuda v. Commissioner, 79 T.C. 714, 719 (1982), affd. 731 F.2d 1417 (9th Cir. 1984). While the structure of the arrangements may reflect ingenuity and imagination, 'we must not be beguiled by such ingenuity-- we must pursue the 'paper chase' to ferret out the substance of the arrangements to determine the proper tax treatment.' Estate of Helliwell v. Commissioner, 77 T.C. 964, 983 (1981). We have carefully considered the record and we must conclude that the 'sale' of the 'processes, methods and procedures' by Erhard to the Panamanian corporation and the subsequent 'license, of such 'processes, methods and procedures' obtained by petitioner from the Panamanian corporation for $1,200,000 was completely without substance and served no purpose or utility apart from their anticipated tax consequences. Erard, who originated the Body of Knowledge, was unable to elucidate any valid business purpose whatever for the decision to first sell his concept for $1,000,000 to a foreign entity (which was unknown to him at the time) and then to pursue his new endeavor under a license granted by Presentaciones Musicales to Erhard Seminars Training and under an employment contract that came to petitioner via Presentaciones Musicales. [FN6] There is no evidence of the consideration prompting the parties in the 'sale' agreement to place a value of $1,000,000 (and a guarantee of $6,000,000 in gross income) on the embryo Body of Knowledge in 1971. Moreover, the spurious nature of the sale is underscored by the fact that the sale price of $1,000,000 was never paid to Erhard. Nor is there any indication in the record of any valid considerations that led to the figure of $1,200,000 for the 10-year license of the Body of Knowledge obtained by petitioner from Presentaciones Musicales. The illusory nature of the license is further demonstrated throughout the years here in issue by the actions of the parties involved. Initially, it appears that petitioner began to conduct est standard training sessions some time in October 1971, well before the date of the license agreement with Presentaciones Musicales. Under an agreement dated 1973 Presentaciones Musicales reacquired from petitioner a portion of the exclusive license rights for $4,166.66 per month for the balance of the original 10-year license term. Yet petitioner inexplicably continued to amortize the license as before at the annual rate of $120,000. [FN7] Erhard, whose concepts were at the core of all these agreements, repeatedly displayed unfamiliarity with key features of said agreements. His lack of awareness extended even to his own employment agreement which set forth various detailed terms and mutual obligations which, insofar as the record shows, were virtually ignored by the parties.
The chimerical nature of these transactions is further underscored by the mosaic of transactions which took place when petitioner ceased operations in September 1975. On September 1, 1975 Presentaciones Musicales and Erhard executed a 'Termination Agreement' terminating the agreement of sale and the employment agreement of October 4, 1971 and on the same date Presentaciones Musicales executed an agreement purporting to again sell all of its 'right, title and interest' in the Body of Knowledge to Welbehagen, a Netherlands corporation, for $15,000,000. Thereupon, est, an educational corporation (the Nevada corporation formed on or about September 1, 1975 with virtually all of the same management, employees and training facilities as petitioner) immediately obtained a 10-year license for the Body of Knowledge for $10,000,000. Initially, it appears that Presentaciones Musicales was selling an asset it did not then own. The September 1975 'Termination Agreement' terminated the agreement of sale and the employment agreement of October 4, 1971. Since the October 4, 1971 agreement of sale explicitly recited that the termination of either agreement (i.e., the agreement of sale or the employment agreement) would automatically terminate the other agreement, it would appear that the asset which was purportedly sold by Erhard to Presentaciones Musicales simply reverted back to Erhard. It is also difficult to reconcile these events with a subsequent 'Exclusive License' in February 1976 in which Erhard, as 'owner of the rights in and to the Body of Knowledge known as Erhard's Seminars Training' purported to transfer such rights to est, an educational corporation. [FN8] In short, it does not appear that Erhard ever parted with or diminished his control over the Body of Knowledge. The denouement of these various transactions involving the Body of Knowledge is that in 1981 Erhard, now self-employed, was presenting his est standard training and the various seminars under the name of Werner Erhard and Associates.
It is clear on this record that the various agreements and transactions discussed above were utterly without economic reality and substance and that the sole purpose of this elaborate paper facade was to obtain tax deductions. Consequently these transactions will not be given effect for tax purposes. Cf. Knetsch v. United States, 364 U.S. 361 (1960). We conclude therefore that petitioner is not entitled to amortization deductions with respect to the alleged license engendered by these transactions in each of the taxable years ended April 30, 1972 through 1976. Respondent is sustained on this issue.
BANKING LIMITED Our conclusion that the licensing agreement as well as the other agreements were devoid of economic substance also impugns the validity of the purported loans created with the ostensible purpose of carrying out such agreements and the related 'interest' expense deductions here in dispute. [FN9] In connection with its 'License Agreement' of December 4, 1971, petitioner purportedly obtained a loan of $1,000,000 from International Aesthetics. [FN10] The loan was arranged through Margolis. Inexplicably, Erhard executed TWO notes dated December 14, 1971, each for $1,000,000, payable to International Aesthetics, one of them on a pre-printed form designated as 'Note Number 1' and the other a typewritten version. It does not appear that any security arrangement was made for the loan. The typewritten version charts the subsequent assignment of the note from International Aesthetics to Presentaciones Musicales (on February 28, 1974), then from Presentaciones Musicales to World Entertainers (on March 4, 1974) and to Antigua Banking (on March 12, 1974). Neither Erhard nor Scheaf appears to have any independent knowledge of the circumstances surrounding the loan.
The manner in which the loan was structured is also illuminating. It appears that on December 14, 1971 the lender, International Aesthetics, executed a note in favor of Associated Arts for $6,911,835 and the following day (December 15, 1971) International Aesthetics opened a checking account with the Union Bank (Wilshire Center, regional head office) in Los Angeles with a deposit of $7,000,000. On the same date this account was charged with several charges in the total amount of $7,000,000, including an unexplained charge of $1,200,000. In a letter dated December 14, 1971 Scheaf, representing petitioner, authorized the Union Bank (Wilshire Boulevard at Western) to transfer $1,200,000 to Presentaciones Musicales. The record also shows that petitioner opened a checking account with the Union Bank in San Jose with a deposit of $1,200,000 and withdrew this same amount on the same day. Yet, the record also indicates that an account charge issued by the Union Bank shows that this amount was remitted to a bank account of Presentaciones Musicales in Curacao, Netherlands Antilles on December 15, 1971. In any event, it appears that the capital stock of International Aesthetics was acquired by Associated Arts on December 14, 1971 and that the stock of International Aesthetics held by Associated Arts was acquired by Presentaciones Musicales on June 21, 1973. The close relationship of these entities, which are sometimes described as 'system entities' controlled directly or indirectly by the Margolis law office and used by it to implement tax planning, underscores the circular and economically meaningless paths of both the loan proceeds and the promissory note initially executed by Erhard for petitioner. In a comparable situation this Court refused to recognized a circular movement of funds as creating a valid debtor-creditor relationship. See Karme v. Commissioner, 73 T.C. 1163 (1980), affd. 673 F.2d 1062 (9th Cir. 1982). We find on this record that the purported loans to petitioner from International Aesthetics were without economic substance and did not create a valid debtor-creditor relationship. Hence, petitioner may not deduct any amount paid as interest to International Aesthetics during the period here involved.
We reach the same result with respect to the interest paid in connection with the purported loans from Antigua Banking Limited, which was an entity controlled by Margolis. Again we have the same pattern of money transfers and note exchanges, purportedly legitimized by meticulous book entries, which bear no vestige of economic substance. Inexplicably petitioner purportedly borrowed some $2,268,500 (evidenced by a series of demand notes from Antigua Banking Limited which in turn borrowed some $3,870,000 from petitioner). It appears that these loans were generally unsecured. On occasion, the purported loans would even cross paths, with loans going both ways on the same date. We do not believe that this busy shuttle of documents establishes a genuine indebtedness between the parties involved. cf. Karme v. Commissioner, supra.- The fact that appropriate book entries were made is not controlling. Glasgow Village Development Corp. v. Commissioner, 36 T.C. 691 (1961). Nor does the mere movement of funds between the entities under these circumstances constitute a substantive transaction for tax purposes. The transactions here involved are completely devoid of economic reality and it readily appears that they have no economic significance beyond expected tax benefits. We conclude that the purported indebtedness was not genuine and therefore petitioner is not entitled to any deduction as interest under section 163 for the amount paid.
Respondent disallowed deductions claimed by petitioner in the taxable years ended April 30, 1973 through 1976 for certain wardrobe expenses in the respective amounts of $11,116, $14,558, $22,038 and $17,831 and also disallowed a deduction claimed by petitioner in the taxable year ended April 30, 1975 for laundry and dry cleaning expenses in the amount of $4,426. The expenditures were incurred by petitioner primarily for Erhard's wardrobe. We do not believe that the wardrobe and wardrobe maintenance expenses incurred by petitioner constituted ordinary and necessary business expenses within the meaning of section 162(a). To qualify as business expenses under section 162(a), the expenditures in question must be directly connected with or pertaining to the taxpayer's trade or business. Section 1.162-1(a), Income Tax Regs. Here, the expenditures in issue were purportedly incurred pursuant to the employment contract of October 4, 1971 between Erhard and Presentaciones Musicales (which contract was then assumed by petitioner) and executed concurrently with the agreement of sale of the Body of Knowledge by Erhard to Presentaciones Musicales. Under the so-called employment agreement, petitioner agreed to provide Erhard with an initial wardrobe allowance of $5,000 and to provide him with a monthly clothing budget of $500. We have concluded above that the various agreements and transactions beginning with the initial agreements of October 4, 1971 between Erhard and Presentaciones Musicales lacked economic reality and may be disregarded for tax purposes. Consequently, the terms of the employment contract itself (which came to petitioner via Presentaciones Musicales) provide little support for petitioner's contention that the expenditures for Erhard's wardrobe constitute ordinary and necessary business expenses under section 162(a).
To prevail, petitioner must show that the expenditures were directly connected with or pertained to petitioner's business. Kornhauser v. United States, 276 U.S. 145, 153 (1928) (for purposes of section 162, the expense must bear a direct and proximate relationship to the taxpayer's trade or business); section 1.162- 1(a), Income Tax Regs. Petitioner's contention that the wardrobe expenses were undertaken for the business and not for the personal benefit of the employee is unpersuasive. There is no perceptible connection between the continuous expenditures over the years or Erhard's wardrobe and the business in which petitioner was engaged. The wardrobe expenses incurred by petitioner for Erhard consisted of ordinary, conventional items of clothing, i.e., shirts, slacks, jackets, sweaters, and shoes, which were undeniably suitable for general or personal wear. It is evident on this record that the expenditures neither benefited nor were intended to benefit the petitioner's business activities. The steady acquisition of this wardrobe over a period of some four years at considerable expense strongly suggests that the expenditures were geared to and dictated by Erhard's personal needs rather than the purported exigencies of petitioner's business. In any event, the requisite nexus between the wardrobe expenditures and petitioner's trade or business has not been established. See Commissioner v. Heininger, 320 U.S. 467 (1943). We conclude on this record that the wardrobe and wardrobe maintenance costs incurred throughout the period involved may not be deducted by petitioner as ordinary and necessary business expenses under the provisions of section 162(a).
Petitioner claimed a deduction in the taxable year ended April 30, 1974 for medical expenses for the benefit of Erhard and his wife Ellen in the amount of $1,466 which was disallowed by respondent. To qualify as an ordinary and necessary expense under section 162(a), the expense must bear a direct relationship to the taxpayer's trade or business, i.e., it must be appropriate and helpful to the taxpayer's trade or business. See Commissioner v. Heininger, 320 U.S. 467 (1943); see also section 1.162-1(a), Income Tax Regs. The necessary relationship does not exist here. Petitioner's reliance on the so-called employment contract to qualify this deduction as a business expense is unpersuasive. Moreover, petitioner's effort to categorize this expense as a payment under a medical plan of the employer (see section 105(b)) is simply not supported by the record. Petitioner's argument that Erhard would not have accepted employment unless his wife and children received assurance of adequate medical care provides no support for the deductibility of this expenditure. See J. Gordon Turnbull, Inc. v. Commissioner, 41 T.C. 358, 378 (1963), affd. 373 F.2d 87 (5th Cir. 1967). We conclude on this record that petitioner is not entitled to a deduction for the medical expense incurred in the amount of $1,466 in the taxable year ended April 30, 1974.
Petitioner claimed a deduction for food and beverage expenses in the taxable year ended April 30, 1975 in the amount of $24,503 (which included food and beverage expenses pertaining to the office of Erhard in the amount of $13,072). Respondent has stipulated that $17,967 of the amount claimed by petitioner is deductible. The remaining $6,536 still in dispute represents one-half of the $13,072 expenditures pertaining to the office of Erhard. Petitioner claimed a deduction for food and beverage expenses in the taxable year ended April 30, 1976 in the amount of $28,457, of which $19,257 was claimed under cost of goods sold and $9,200 was claimed under other deductions. Respondent disallowed a deduction for the entire amount of $28,457.
Petitioner has the burden of proof. Welch v. Helvering, 290 U.S. 111 (1933); Rule 142(a). With respect to the taxable year ended April 30, 1975, petitioner made no serious effort to show that it was entitled to any deduction for food and beverage costs in excess of the amount ($17,967) allowed by respondent. We therefore sustain respondent with respect to the taxable year ended April 30, 1975. With respect to the taxable year ended April 30, 1976, there is evidence in the record as to the general practice followed by petitioner of providing food and beverages to its employees throughout the period here involved and also to pay for staff luncheons on the business premises of the petitioner. We believe that the business necessity for making these expenditures was clearly dictated by the method of operation adopted by petitioner to conduct its unique activities. It also appears that petitioner conducted training sessions for children and that food and beverages were necessarily provided for the children during the sessions and included as part of the tuition. The special training sessions for teenage children included a 'wilderness component' which lasted from six to ten days. It also appears that some portion of these expenditures was for the office of Erhard which apparently was regarded as a division within petitioner's corporate structure. The evidence shows that detailed records were kept by petitioner for these various expenditures. We believe that petitioner has convincingly established both the business necessity of these expenditures and the amount of the expenditures incurred for food and beverages. We hold on the basis of this record that petitioner is entitled to a deduction for food and beverage expenses incurred in the taxable year ended April 30, 1976 in the total amount of $28,457.
Petitioner claimed a business expense deduction under section 162(a) for automobile costs in the taxable year ended April 30, 1976 in the amount of $8,558 which was disallowed by respondent. Certain employees of petitioner were allowed expense accounts in connection with their duties and they were required to submit periodic and detailed accountings to petitioner. Upon verification, the employees would be reimbursed for such expenses. The record shows that petitioner maintained meticulous records identifying the employees involved, the amounts of the reimbursements and the geographical area involved. On this record, we conclude that petitioner is entitled to a business expense deduction under section 162(a) for the taxable year ended April 30, 1976 for automobile expenses in the amount of $8,015.
Petitioner deducted $106,655 for travel and entertainment in the taxable year ended April 30, 1973. Included in this amount are (1) the expenditures of $2,594 incurred by Werner Erhard on a trip to India and (2) the cost of two around-the-world airplane tickets ($4,794) for Erhard and Ingrasci. Both of these items are in dispute. Also in the taxable year ended April 30, 1973 petitioner deducted $33,987 for gift and entertainment expenses. Of this amount respondent disallowed $5,739.58 pertaining to Erhard's trip to India and $1,447.13 which pertained to gifts generally.
In 1973 Erhard and Ingrasci, who was employed by petitioner as an administrative assistant to Erhard, traveled to India for a period of three or four weeks, with some three or four days in Hawaii. They also embarked on a world trip sometime in 1973. Petitioner has the burden of showing that the trip related primarily to its trade or business. Section 1.162-2, Income Tax Regs.; Rudolph v. United States, 370 U.S. 269 (1962). The testimony with respect to the Indian trip is extremely vague and replete with broad generalities. The visits to individuals in India who were in some way versed in aspects of Indian philosophy appear to be incidental in nature. We have carefully considered the record and we are persuaded that the trip to India was primarily personal in nature. Petitioner has failed to establish the requisite nexus between the trip to India and its trade or business. We reach the same conclusion with respect to the around- the-world airplane tickets for Erhard and Ingrasci since the record is virtually silent as to the purpose of such trip. We hold that petitioner is not entitled to a deduction for the expenditure of $2,594 incurred by the two individuals on the trip to India and further, that petitioner is not entitled to a deduction for the world-trip tickets in the amount of $4,794.
Erhard and Ingrasci purchased numerous gifts, some for individuals they visited in India but mostly for friends in the United States. They also made expenditures for personal clothing and they acquired numerous objects including such items as old ivory pieces, antique plates and jars, old coins and a copper buddha statue. The evidence is extremely vague as to the number of recipients of gifts in India. Ingrasci could not recall the disposition of some items of significant value which were purchased in India. We are unable to find on the basis of this unsatisfactory record that the gifts were intended for or served any business purpose. Nor is there any meaningful effort to present any evidence with respect to the category for gifts and entertainment in the amount of $1,447.13. Moreover, petitioner has failed to meet the requirements of section 274(d) which sets forth stringent substantiation requirements in order to qualify expenditures of this nature for deductibility under section 162(a). We hold therefore petitioner is not entitled to a business expense deduction under section 162(a) for the gift expenditures involved.
Petitioner claimed a business expense deduction for travel and entertainment for the taxable year ended April 30, 1974 of $136,432 which amount included $4,868.39 representing expenses incurred by Ellen on a trip to Europe. Respondent disallowed one-half of the $4,868.39 deduction claimed with respect to Ellen's expenditures. Petitioner has the burden of proof. Rule 142(a). Ellen accompanied her husband on a trip to Europe in the taxable year ended April 30, 1974. The expenditures in question are not deductible unless it can be adequately shown that her presence on the trip had a bona fide business purpose. Section 1.162-2(c), Income Tax Regs.; cf. Silverman v. Commissioner, 28 T.C. 1061 (1957), affd.253 F.2d 849 (8th Cir. 1958). It must be shown that she provided substantial service directly related to the petitioner's business. See Weatherford v. United States, 418 F.2d 895 (9th Cir. 1969). Erhard testified generally as to the purposes of the trip to Europe and, with respect to Ellen's presence on the trip, he alluded to secretarial duties but stated that the real reason was to provide 'a sense of family' which would somehow inure to the benefit of petitioner. We have considered the record as a whole, including the self-serving resolution of petitioner's board of directors authorizing Ellen to go on the trip, and we are unpersuaded that Ellen's presence on the trip was dictated by the exigencies of petitioner's business. The purported benefits to petitioner are simply too incidental and tenuous to cause her expenses to qualify as deductible business expenses. We hold that petitioner is not entitled to a business expense under section 162(a) in the taxable year ended April 30, 1974 for any expenses incurred by Ellen on the trip to Europe in excess of the amount allowed by respondent.
In 1972 petitioner rented space for its business operation in the property hereinafter referred to as the Franklin House in San Francisco, California from one Ann Sheehan. Late in 1972 or early in 1973 petitioner decided to buy the property for $142,500 and on January 31, 1973 obtained a real estate loan commitment from Barclays Bank of California in the amount of $98,000. On March 30, 1973 a grant deed (executed on March 22, 1973) transferring ownership from Ann Sheehan to petitioner was recorded. At this point a series of purported transactions took place, all under date of March 30, 1973; (1) Scheaf (on behalf of petitioner) and one Lee Neuhaus (on behalf of the Continental Title Company) executed a Holding Agreement reciting that title to the Franklin House property was conveyed by petitioner to the Continental Title Company to be held for petitioner and subject to petitioner's instructions; (2) petitioner authorized Continental Title Company to hold the Franklin House property under the Holding Agreement for the benefit of the Maryelle Corporation; and (3) petitioner thereupon leased the Franklin House from the Maryelle Corporation for a 10-year period at a monthly rental of $3,750. [FN11] On March 1, 1974 Maryelle Corporation authorized Continental Title Company to hold the Franklin House property for the benefit of Associated Convalescent Enterprises. On April 1, 1974 Associated Convalescent Enterprises and petitioner executed a modification of the lease under which the monthly rental was increased to $5,000. Petitioner claimed rental expense deductions in the taxable years ended April 30, 1974 and 1975 with respect to the Franklin House property in the respective amounts of $41,250 and $60,000 which were disallowed by respondent.
Section 162(a)(3) allows a deduction for rental payments required to be made for the business use of property. It is incumbent upon us to determine whether the arrangements involved were in fact bona fide. In Falsetti v. Commissioner, 85 T.C. 332, 347 (1985) this Court defined a 'sham in substance' as the expedient of drawing up papers to characterize transactions contrary to economic realities and which have no economic significance beyond expected tax benefits.' Economic realities govern over the form in which a transaction is cast. See Gregory v. Helvering, 293 U.S. 465 (1935); cf. Zmuda v. Commissioner, 79 T.C. 714 (1982), affd. 731 F.2d 1417 (9th Cir. 1984). After careful consideration of the entire record, we conclude that the arrangements to move the title in the Franklin House to Continental Title Company and then to authorize Continental Title Company to hold said title for the benefit of Maryelle Corporation and then for Associated Convalescent Enterprises were completely devoid of economic reality and will not be given effect for tax purposes. [FN12] Scheaf, who executed several of the documents here involved in her capacity as petitioner's president, appeared thoroughly unfamiliar with the transactions involved and with the reasons for entering such transactions. She did not know how the monthly rental payments of $3,750 was arrived at. Nor did she know the reasons for the subsequent increase of the monthly rental from $3,750 to $5,000 in spite of the fact that she signed both the original 10-year lease and the modification of said lease. Moreover, the economic artificiality of the grossly inflated monthly rentals is underscored by the testimony in the record from a witness who was long involved in the real estate business, was thoroughly familiar with the rental of property in the San Francisco area, knew the area of the Franklin House and was familiar with the actual property here involved. The economic or business rationale for the sudden designation of Maryelle Corporation and, later, Associated Convalescent Enterprises as the entities for whose benefit the Franklin House was held by Continental Title Company remains unexplained except to play the role of 'lessors' of the Franklin House property. There is nothing in the record to explain the derivation or the nature of the interest in the property by these two entities. It is significant that both of these entities were among the so-called 'system entities' managed by individuals from the office of Margolis. There is no effort to explain why (apart from tax considerations) petitioner, which had just acquired the property with a loan from Barclays Bank of California, [FN13] would immediately embark on a transaction which did nothing except to engender an onerous (and inflated) monthly rental liability. The subsequent events involving the Franklin House property are also revealing with respect to the true ownership of the Franklin House property throughout this period. By letter dated March 22, 1977, Margolis informed Continental Title Company, which ostensibly was holding title to the Franklin House property for the benefit of Associated Convalescent Enterprises, that Associated Convalescent Enterprises had disposed of its interest in the property on February 1, 1977 to a Nevada corporation known as est, an educational corporation. Est, an educational corporation, had been formed on or about September 1, 1975 and continued the standard training previously conducted by petitioner, with substantially the same management, employees and training facilities used by petitioner. On June 1, 1981 est, an educational corporation, leased the Franklin House property for a period of 30 years to Erhard doing business as Werner Erhard and Associates and a month later Erhard, doing business as Werner Erhard and Associates, exercised an option to purchase the Franklin House property. We hold on the basis of this record that, in view of the absence of any economic reality or business purpose in the transactions above described, petitioner is not entitled to a deduction for rental payments in the taxable years ended April 30, 1974 and 1975 in the respective amounts of $41,250 and $60,000.
Respondent determined that petitioner is liable for the additions to tax under section 6653(a) for the taxable years ended April 30, 1972 through 1975. Section 6653(a) imposes an addition to tax if any part of the underpayment is due to negligence or intentional disregard of rules or regulations. Petitioner has the burden of proof. Bixby v. Commissioner, 58 T.C. 757, 791 (1972). Petitioner has made no serious effort to prove that the respondent's determination is erroneous and has not addressed this issue on brief. Under the circumstances we sustain respondent's determination as to the additions to tax. Decisions will be entered under Rule 155 upon the disposition of the severed partnership issues.
FN1 All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. All rule references are to the Tax Court Rules of Practice and Procedure, as amended, unless otherwise noted.
FN2 In the relevant statutory notices of deficiency, respondent disallowed an investment credit of $749 claimed by petitioner in the taxable year ended Apr. 30, 1973 and also disallowed net operating loss deductions claimed by petitioner in the taxable years ended Apr. 30, 1974 and 1975 in the respective amounts of $19,868 and $26,661. Petitioner presented no evidence or argument with respect to these issues at the trial and hence said issues must be deemed conceded by petitioner. See Rule 142(a).
FN3 It appears that the concepts, or 'know-how' contained in the so-called Body of Knowledge were imparted through the est standard training. The est standard training was a 52 to 60-hour session held two consecutive weekends with groups of 200 to 250 trainees. The sessions were conducted by individuals who qualified as 'Trainers.' From the inception of the training session late in 1971 through at least the year 1972, Erhard personally conducted all the sessions. Additional trainers, all selected by Erhard, were developed through 1975. Between 1971 and 1975 Erhard also developed other programs, including communication workshops, the relationship program and graduate seminars. Tuition or fees were charged by petitioner for attendance at the est standard trainings, workshops, lectures and other activities. Erhard testified that a goal of est standard training was to enable individuals to be 'more in charge of the quality of their life.' He also described the est standard training as 'know-how which we pass on to people about what to do to have the ability to make their lives work for them more effectively show up in their lives.' He further explained that the know-how was not a mere recipe or prescription, but a finding in one's self, a discovering in one's self, an ability that one had not been aware of before, so that the results of the training showed up in people's life, not like a prescription, but like an ability to be in life and to deal with certain things in life that was not there before . . . the training is not a philosophy, but it really enables people, like gives them the know-how to deal with what their philosophy is and the ability to create for themselves a more effective philosophy in their lives . . . the training delivers to people the know-how to open up that aspect of their life that makes life really present for them, instead of living more like a concept . . .
See generally est of Hawaii v. Commissioner, 71 T.C. 1067 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981).
FN4 It was not until Nov. 1972 that a stock certificate was issued by petitioner to its stockholder International Aesthetics, a corporation managed in the Margolis law office. Subsequent transfers of petitioner's stock were from International Aesthetics to California Aesthetics and from there to Presentaciones Musicales (on Nov. 23, 1976). We note that neither Erhard nor Scheaf, at one time petitioner's president, was able to shed much light on these transfers of petitioner's stock.
FN7 When petitioner ceased its est standard training activities on or about Sept. 1, 1975 and became Twine, Inc., the unamortized license in the amount of $760,000 was reclassified as an account receivable and remained on the books until Dec. 30, 1976 when a transfer of $760,000 from Presentaciones Musicales to Twine, Inc. was made to close the account. It should be noted that Presentaciones Musicales at that time owned all the stock of Twine, Inc., a corporation managed from the Margolis law office.
FN10 On Dec. 14, 1971 petitioner's board of directors authorized Erhard, as chairman of the board, and Scheaf, as president, to borrow this amount from International Aesthetics. However, the record shows that Erhard and Scheaf were not elected to the above corporate offices until June 23, 1972.
FN11 Petitioner contends that, under California law, the effect of its Mar. 30, 1973 letter to Continental Title Company authorizing Continental Title Company to hold the Franklin House for the benefit of Maryelle Corporation was to transfer equitable title to the Franklin House to Maryelle Corporation.
FN12 In view of our conclusion that the transactions involving the Franklin House property were simply paper transactions without economic validity, there is no need to explore the legal ramifications of the ownership of real property pursuant to holding agreements under California law.
FN13 Soon after the initial spate of transactions invoking the transfer of title to the Franklin House property, Barclays Bank of California made it clear to petitioner that such transactions would in no way affect the outstanding deed of trust.

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