t c memo united_states tax_court darrell rooney petitioner v commissioner of internal revenue respondent docket no filed date brent e vallens for petitioner scott b burkholder for respondent memorandum findings_of_fact and opinion marvel judge respondent determined a dollar_figure deficiency in petitioner’s federal_income_tax petitioner timely filed a petition contesting respondent’s determination after 1monetary amounts are rounded to the nearest dollar concession sec_2 the issues for decision are whether respondent is precluded from disallowing petitioner’s schedule c amortization3 expense deduction for because he allowed a similar deduction during an audit of petitioner’s form_1040 u s individual_income_tax_return and whether petitioner is entitled to the schedule c amortization expense deduction he 2on brief respondent concedes that on the schedule c profit or loss from business petitioner is entitled to deduct depreciation of dollar_figure with respect to assets petitioner acquired in and and to deduct legal and professional fees of dollar_figure although the parties included the depreciation of archival photos and equipment of dollar_figure and dollar_figure respectively in the description of the disputed expense deductions contained in stipulation of the stipulation of facts respondent states on brief and the record establishes that petitioner deducted those amounts as part of another category on his schedule c which respondent allowed accordingly we disregard stipulation to the extent described herein as inconsistent with the record as follows from the foregoing only the cost_recovery of assets that petitioner acquired in and included in calculating the disputed deduction claimed on his schedule c remains at issue 3generally depreciation is a reasonable_allowance_for_exhaustion_wear_and_tear and obsolescence sec_167 i r c and refers to the gradual reduction in the value of tangible_property as opposed to intangible_property see black’s law dictionary 8th ed with respect to intangible assets the internal_revenue_code generally uses the word amortization see eg sec_197 i r c petitioner claimed depreciation and amortization expenses in two categories on his schedule c the depreciation and sec_179 i r c expense deduction category and the amortization expense deduction category only the latter category is at issue for simplicity we shall hereinafter refer to the disputed category as the cost_recovery deduction claimed for under sec_167 a or any other cost_recovery section of the code findings_of_fact the parties have stipulated some of the facts which we incorporate in our findings by this reference petitioner resided in california when he filed his petition i petitioner’s professional background petitioner is a film director animator writer and producer who was employed during by walt disney pictures television walt disney petitioner studied animation film and illustration in college and graduated with high honors in the 1980s petitioner took classes on directing editing acting writing and screenwriting during his studies petitioner learned about the importance of a clippings file or research library which is a collection of photographs and illustrations from magazines and books of various images such as cars weather animals or people petitioner uses his research library as a tool when designing scenes since petitioner has been involved in the production of animated tv series episodes and films for walt disney turner 4unless otherwise indicated all section references are to the internal_revenue_code code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure 5in addition to the term research library the parties also sometimes use reference library feature animation and universal pictures petitioner has worked on such projects in various capacities including writer editor layout artist animator storyboard artist head of storyboards sequence director producer and director in the 1990s petitioner started writing screenplays some of which he sold in the mid-1990s walt disney hired petitioner petitioner’s directing credits for walt disney include the animated films mulan lady and the tramp ii scamp’s adventure the three little pigs and the lion king ii simba’s pride in addition to his employment with walt disney petitioner has worked on several independent projects over the years petitioner has pitched some of the projects to studio executives or production companies and some pitches resulted in sales in years before if a pitch did not result in a sale petitioner did not abandon the project instead he might pitch it again when meeting a new producer or development executive petitioner’s goal is to make himself a more valuable and marketable director and to transition from directing animated films to directing live action feature films ii petitioner’s independent projects and the research library in petitioner had several open projects many of which he has been trying to market since the 1990s the projects are described below a jean harlow in petitioner’s principal independent project involved jean harlow ms harlow a movie star of the 1930s who died in at the age of petitioner has been fascinated with ms harlow since the 1970s when petitioner started writing a screenplay about ms harlow in the early 1990s he realized that he lacked necessary information and he started to expand his research library on ms harlow which was limited at that time to inexpensive reprint photos as of the trial date petitioner’s research library on ms harlow contained more than three-ring binders of printed materials the binders are organized chronologically most of the materials in the binders are from through because those were pivotal years in ms harlow’s life the binders 6in addition to the projects described in this section in petitioner started work on the fish out of the water and vikings projects although petitioner bought books for these projects in the record reflects that he did not claim deductions for the cost of the books on his schedule c accordingly we do not discuss these projects and petitioner’s purchases related to them 7the record does not establish that petitioner ever finished the harlow screenplay contain articles from newspapers and movie magazines books loose pages from books and magazine covers petitioner’s research library also contain sec_25 binders of photographs of ms harlow and other materials including letters historical documents contracts personal mementos contact information of fellow researchers and professional associations relating to ms harlow films and vintage radio recordings on tape and cd and in transcript form the photographs vary in quality and include reprints copies of photographs nonprofessional candid photographs archival and autographed photographs and production stills petitioner keeps his binder materials in archival plastic sleeves petitioner purchased most of the materials on ms harlow either at movie memorabilia shows or on ebay petitioner looks for materials that were written about her while she was alive and that were not changed by studio press or magazine editors petitioner considers his collection an encyclopedia of ms harlow’s life petitioner intends to continue acquiring historical material photos letters and other items that illuminate ms harlow’s private life his goal is to collect a research library that is so extensive that he is the first person contacted regarding the availability of items related to ms harlow in petitioner met mark vieira mr vieira a photographer and writer who as of the trial date had written and published seven books on hollywood history mr vieira worked with petitioner in various ways in the process of writing three of the books mr vieira obtained materials on hollywood history from petitioner such as photographs or quotations about the subjects in the books and petitioner was credited in the books before mr vieira also used two photographs from petitioner’s research library for one of his books for which he paid petitioner approximately dollar_figure in late mr vieira asked petitioner whether he would be interested in collaborating on a book about ms harlow and mr vieira and petitioner prepared a proposal for a publisher in date mr vieira met with the publisher’s marketing personnel but the publisher was not interesteddollar_figure 8petitioner also claims he intends to write a screenplay and a book and create a film about ms harlow as of the trial date he had not done any of these things 9after mr vieira rents photographs for use in his books generally he is not obligated to pay a royalty when the book is published 10since then petitioner has expanded his research library to include rare photographs of ms harlow from a sitting in griffith continued b titanic survivors in the late 1980s and 1990s petitioner met survivors of the sinking of the titanic several descendants of survivors and one titanic cross-channel passenger and he interviewed them on film petitioner testified that in the 1990s subsidiaries of twentieth century fox and several other production companies licensed some part of the footage in the mid-1990s petitioner also sold some titanic travelogue documentariesdollar_figure petitioner’s research library concerning the titanic contains photographs of the people he interviewed and footage of the interviews it also contains materials from magazines and books relating to the titanic its passengers and crew and interview materials c cass elliot in petitioner started his cass elliot project which contemplates the development of a full-length musical feature film based on the life of singer cass elliot of the mamas the papas a popular musical group of the mid-1960s petitioner interviewed people who knew cass elliot and he collected materials on her including books magazines and audio continued park however the record is not clear whether petitioner acquired these photographs in or later 11with the centennial of the sinking of the titanic coming up in petitioner hopes to repackage and sell the documentary footage materials petitioner also had occasional meetings with writers or producers on this project in years before d calamity jane the calamity jane project which petitioner began in contemplates the creation of an animated musical film about calamity jane petitioner pitched the project to a studio sometime before but the studio later abandoned the project and he resumed developing his original idea in petitioner pitched the project to two additional studios without success petitioner acquired materials for the project including dvds vhs tapes books magazines and photographs of calamity jane her contemporaries and the wild west of the 19th century e joan of arc in petitioner began his joan of arc project which he envisions making into an animated full-length production petitioner’s research library on joan of arc contains books films photographs and illustrations in petitioner unsuccessfully pitched the project to walt disney television animation f the black donnellys in petitioner began the black donnellys project which envisions the development of a full-length feature film the project focuses on an infamous family of irish immigrants who moved to southern ontario canada in the early to mid 19th century petitioner acquired books photographs magazine articles and other materials related to the project and visited london ontario where the black donnellys lived in petitioner unsuccessfully pitched the project to walt disney pictures iii audit of petitioner’s return in respondent began examining petitioner’s return audit on his schedule c petitioner deducted depreciation and amortization expenses of dollar_figure in the course of the audit respondent accepted petitioner’s schedule c depreciation and amortization deduction as reported iv petitioner’s return petitioner’s accountant judy vargas ms vargas prepared his return and petitioner timely filed it petitioner reported dollar_figure in wages for his work as a director for walt disney petitioner attached to his return a schedule c on which he described his principal business as that of a producer and filmmaker the schedule c reported no income or gross_profit and a dollar_figure loss as part of the schedule c expenses petitioner deducted dollar_figure as the cost_recovery deduction see supra note petitioner depreciated or amortized most assets on a straight-line 5-year basisdollar_figure 12the record indicates that of the categories remaining at issue petitioner amortized promotion as a 5-year_property continued of the dollar_figure cost_recovery deduction reported on petitioner’s schedule c that respondent disallowed the following components remain at issue description furniture fixtures goodwill promotion artist supply research tapes theater goodwill dues and periodicals books promotion salary promotion animation art photos research library research photo promotion goodwill goodwill reference library reference library vint magazine library total year acquired cost_basis dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number deduction dollar_figure big_number big_number big_number big_number big_number big_number because petitioner recovered the cost of most of the assets using a 5-year cost_recovery period his depreciation schedule included several assets that petitioner had acquired in and but had not fully depreciated or amortized the depreciation schedule also included categories of assets purchased after which are similar to the categories on the depreciation schedule such as research photos and library continued using the 200-percent declining balance mid-quarter convention method research acquired in and promotion goodwill expenditures in and respondent audited petitioner’s return and issued a notice_of_deficiency that disallowed in full the dollar_figure cost_recovery deduction and made certain computational adjustments in the form 886-a explanation of items attached to the notice_of_deficiency respondent stated that the deduction is disallowed because this item is not an allowable deduction i burden_of_proof opinion the commissioner’s determinations are presumed correct and the taxpayer ordinarily bears the burden of proving a determination is erroneous rule a 290_us_111 moreover deductions are a matter of legislative grace and the taxpayer bears the burden of proving that he is entitled to any claimed deduction 503_us_79 petitioner does not contend that sec_7491 shifts the burden_of_proof to respondent and the record does not permit us to conclude that the requirements of sec_7491 are met accordingly petitioner bears the burden of proving that he is entitled to the claimed deduction ii the parties’ arguments a respondent respondent does not argue that petitioner was not in the trade_or_business of being a producer and filmmaker nor does respondent contest that petitioner actually spent the amounts he claimed to have spent respondent contends instead that petitioner’s expenditures at least those related to the ms harlow project were personal because the expenditures were to enhance petitioner’s personal collection rather than to carry on his business as a producer and filmmaker even if the relevant expenses were business_expenses the amounts spent on items related to ms harlow were not reasonable and even if we were to conclude that depreciating the assets was proper petitioner incurred the costs in the process of creating long- lived assets the created assets and he should have capitalized the expenses under sec_263a which permits a taxpayer to recover costs only when the taxpayer places the created assets in service respondent’s sec_263a argument was raised for the first time in his opening brief petitioner anticipated the argument because he refers to it in his opening brief filed 13in his opening brief petitioner lists but does not address other issues such as whether the expenses were reasonable and necessary whether the expenses are subject_to the hobby_loss_rules of sec_183 and whether petitioner may deduct expenses continued concurrently with respondent’s and does not assert that the argument is a new_matter that either shifts the burden_of_proof to respondent or precludes our consideration of the argument however we do not need to consider respondent’s sec_263a argument because we deny petitioner’s cost_recovery deductions on other grounds b petitioner petitioner’s posttrial briefs focus primarily on one issue --the effect of the audit on respondent’s adjustments to petitioner’s schedule c cost_recovery deductions petitioner’s principal argument in his opening brief is that the audit resulted in an agreement on which petitioner is entitled to rely in subsequent years even in his reply brief petitioner focuses solely on the effect of the auditdollar_figure as a result petitioner’s opening and reply briefs are not particularly helpful in deciding the issues continued with respect to creative projects which are under development but which have not yet been produced and sold 14petitioner also asserts that the legal issues during trial were different from the issues that were in dispute during the audit according to petitioner during the audit and at the appeals level respondent argued that the assets should be depreciated on a 15-year basis with a midyear convention petitioner also alleges that after the case was docketed respondent changed course and claimed that petitioner incurred the expenses in pursuit of a hobby petitioner however does not allege any prejudice or unfair surprise and we conclude there is none respondent confirmed during trial and in his reply brief that sec_183 is not at issue in his opening brief petitioner states that he was prepared to present evidence regarding whether the expenditures were ordinary and necessary but abbreviated his presentation in response to comments by the court during the trial while petitioner’s point is not entirely clear he appears to imply that he was misled by the court into abbreviating his case at trial he is mistaken we warned petitioner on more than one occasion during trial that he had the burden_of_proof and that he needed to introduce evidence to show that the requirements for claiming cost_recovery deductions for the items in question were satisfied for the most part petitioner did not come to trial with the evidence he needed to support the disputed deduction moreover petitioner had ample opportunity to address respondent’s arguments in his posttrial briefs but made a deliberate decision not to do so relying instead on the audit having decided how to try his case and prepare his posttrial briefs petitioner must live with the consequences of his decisions and cannot now complain that any failure of proof rests on anyone’s shoulders but his own 15in his pretrial memorandum respondent relies on sec_162 and argues that petitioner failed to show that the research library expenses were ordinary necessary and reasonable however respondent does not explain how sec_162 is relevant to deductions under the cost_recovery sections of the code cf 97_tc_670 distinguishing sec_168 the authority for deducting an allowance for depreciation in that case from sec_162 iii the effect of the audit petitioner contends that on his schedule c he depreciated assets similar to those on the schedule c and that respondent considered the issue during the audit and allowed the deductions petitioner suggests that at the conclusion of the audit he and respondent entered into a settlement agreement pursuant to which he would depreciate the assets on a 5-year straight-line basis and that he relied on the settlement agreement in computing his federal_income_tax liability petitioner contends that respondent may not repudiate the settlement agreement and is barred from disallowing the depreciation_deductions with respect to the similar categories of assets we disagree the record does not support a finding that the parties entered into a settlement agreement with respect to the audit the record simply reflects that the audit was closed without changedollar_figure moreover the result of a prior audit ordinarily does not bind the commissioner because each tax_year is to be considered separately 394_us_678 although reliance on a prior audit may establish reasonable_cause and good_faith see sec_6664 for the purpose of determining whether the sec_6662 accuracy- 16the record contains respondent’s letter to petitioner dated date showing no adjustments to the schedule c and no deficiency for related penalty applies see eg de boer v commissioner tcmemo_1996_174 the commissioner’s failure to challenge a position in a prior audit does not bar a subsequent challenge with respect to a similar position see 55_tc_28 tesar v commissioner tcmemo_1997_207 accordingly we hold respondent is not estopped from disallowing the disputed cost_recovery deduction in for expenses similar to those that he had allowed in the auditdollar_figure iv petitioner’s evidence at trial the record contains exhibit 34-j which consists of summaries of receipts for items petitioner purchased in petitioner coded most items to show whether the purchase related to a specific project or was general ongoing research petitioner explained that exhibit 34-j was the cover sheet from his box of records for and the box itself contained receipts and a detailed description of each item although petitioner claims that the boxes of receipts for the purchases had similar cover sheets he did not introduce either the summaries or the original receipts into evidence at trial nor did he bring the summaries or receipts to trial 17respondent conceded depreciation_deductions with respect to assets purchased in and that were examined during the audit and for which petitioner claimed a depreciation deduction in see supra note petitioner asserts on brief that before trial his counsel proposed that the boxes of receipts for be offered as evidence at trial according to petitioner respondent’s counsel said that the introduction of those boxes of receipts was unnecessary and inappropriate because the documentation of the expenditures was not an issue in dispute in the case petitioner claims that on the basis of this representation he did not offer as evidence the boxes of receipts for he brought to trial only the box of receipts for and he introduced in evidence only the cover sheet from the box of receipts respondent denies that he prevented petitioner in any way from introducing evidence at no point during trial did petitioner assert that respondent misled him in any way with respect to the records for even when we expressed concern that petitioner was not proving how his purchases were connected to his schedule c activity for example during trial we stated that petitioner’s depreciation schedule reflects categories and that petitioner was not explaining what actually was in each one of these categories during ms vargas’ testimony we expressed concerns about the lack of testimony on how the assets related to petitioner’s schedule c activity at the conclusion of the trial we again stated that the record contained no detail regarding petitioner’s purchases with the exception of purchases made during at no point after we gave these warnings did petitioner’s counsel explain why he did not bring the documents to trial or why he did not attempt to introduce them into evidence nor did he ask us to keep the record open to submit them petitioner also states that during trial his counsel realized that the issues being considered by the court were not the same as the issues raised by the parties petitioner claims his counsel abbreviated his presentation of evidence on the issue of whether the expenditures were ordinary and necessary and switched to presenting evidence on the effect of the audit the effect of the audit was one of the issues in this case and our questioning the parties regarding one issue does not render other arguments of the parties moot or irrelevant moreover because we repeatedly called petitioner’s counsel’s attention to the kind of evidence that would be helpful in deciding whether petitioner was entitled to the cost_recovery deductions he claimed petitioner’s posttrial argument regarding abbreviating his presentation of evidence at trial lacks merit v petitioner’s cost_recovery deduction a cost_recovery in general although petitioner characterized the disputed cost_recovery deduction as an amortization deduction the parties seem to agree that petitioner claimed it under section dollar_figure sec_167 allows as a depreciation deduction a reasonable_allowance_for_exhaustion_wear_and_tear and obsolescence of property if the taxpayer uses such property in a trade_or_business or other income-producing activity see also sec_1_167_a_-1 income_tax regs sec_168 provides that except as otherwise provided therein the depreciation deduction authorized by sec_167 for any tangible_property shall be determined by using the applicable_depreciation_method the applicable_recovery_period and the applicable convention the depreciation system set forth in sec_168 as in effect for is known as the modified accelerated_cost_recovery_system macrs depreciation is an accounting device that recognizes that the physical consumption of a capital_asset in a business activity is a true cost of doing business since the asset is being depleted 418_us_1 a depreciation deduction allows a taxpayer to recover his investment in an income-producing asset over the useful_life of the asset 103_tc_285 affd 65_f3d_329 3d cir as the process of consumption sec_1 income_tax regs allows a taxpayer to claim as deductions the cost of supplies used by him in the practice of his profession including amounts paid for books and furniture with short useful_life petitioner does not claim deductions under sec_1 income_tax regs nor does the record permit us to conclude that any of contested expenses qualified for a deduction under sec_162 continues and depreciation is claimed and allowed the asset’s adjusted_basis is reduced to reflect the distribution of its cost over time commissioner v idaho power co supra pincite ‘ the purpose of depreciation accounting is to allocate the expense of using an asset to the various periods which are benefited by that asset ’ id pincite quoting 364_us_122 under the cost_recovery provisions of the code which have changed considerably over time and are quite complex a taxpayer may under certain circumstances depreciate or amortize an asset used in the active_conduct_of_a_trade_or_business the circumstances vary depending on among other things the type of property involved and the date on which the property is placed_in_service different types of property are subject_to different sets of rules and there are several systems of cost_recovery that may apply eg the accelerated_cost_recovery_system acrs generally in effect for property placed_in_service during macrs generally effective for property placed_in_service beginning after and section dollar_figure assuming for the 19the rules with respect to the amortization of certain kinds of intangible_property are set forth in sec_197 and in other provisions of the code see eg sec_169 pollution_control_facilities neither party contends that the expenditures in question were sec_197 intangibles or that other amortization provisions apply moment that section and sec_263a which postpone cost_recovery under certain circumstances do not apply any analysis of the propriety of a cost_recovery deduction must take into account the type of property for which a taxpayer is claiming a cost_recovery allowance deduction and whether the property is subject_to wear_and_tear decay or decline from natural causes exhaustion and or obsolescence during the time that the property is used in the taxpayer’s business see eg sec_167 sec_168 sec_197 and related regulations if property is not subject_to wear_and_tear to decay or decline from natural causes to exhaustion and or to obsolescence no allowance for depreciation is deductible sec_1_167_a_-2 income_tax regs the regulations under sec_167 provide that personal_property is depreciable under sec_167 if the taxpayer established the useful_life of the property see sec_1_167_a_-1 and b income_tax regs no depreciation under sec_167 is allowed with respect to museum pieces of indeterminable useful_life see 661_f2d_203 sec_263 provides that no deduction shall be allowed for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate or expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made sec_263a provides for the capitalization of certain costs of property produced_by_the_taxpayer see sec_263a b we have held that a painting displayed for business purposes that suffers no wear_and_tear is not depreciable under acrs when the taxpayer failed to prove a determinable useful_life see clinger v commissioner tcmemo_1990_459 under acrs however once the taxpayer establishes that an asset is subject_to exhaustion wear_and_tear or obsolescence the taxpayer does not need to show the useful_life of the asset liddle v commissioner supra pincite selig v commissioner tcmemo_1995_519 even if property might otherwise be subject_to the cost_recovery provisions because the property is adversely affected by use or by the passage of time generally no deduction for personal living or family_expenses is allowed sec_262 and no depreciation deduction is allowed for personal_use_property cf sec_1_167_a_-1 income_tax regs moreover under sec_274 no deduction otherwise allowable is permitted for any entertainment item with respect to an activity which is of a type generally considered to constitute entertainment amusement or recreation unless the taxpayer establishes that the item was directly related to the active_conduct of the taxpayer’s trade_or_business the taxpayer claiming a cost_recovery deduction such as depreciation or amortization ordinarily has the burden of proving that the expenditure is depreciable and or is not a personal_expense and that the requirements of the applicable cost_recovery system have been met see rule a for the reasons set forth below petitioner has failed to carry his burden_of_proof b whether petitioner’s assets were depreciable or personal22 expenditures with respect to assets purchased in petitioner’s depreciation schedule indicates that in petitioner acquired two categories of assets that were included in calculating the disputed cost_recovery deduction reference library and vintage magazine-library materials the reference library items were archival photographs of jean harlow that petitioner purchased in the vintage magazine-library material sec_23 consisted of over vintage magazines related to ms harlow items designated as general ongoing research which included a photo magazines and newspapers and several uncategorized items the items included in the categories described above can fairly be divided into harlow items and non-harlow items the 22respondent’s brief is unclear as to whether respondent contends that all of petitioner’s expenditures including those not related to the harlow project were personal we address other expenses because respondent did not concede the depreciation amount with respect to other assets except as discussed supra note 23we understand that the vint magazine-library category of the depreciation schedule correlates with the dues and periodicals category of exhibit 34-j harlow items include the archival photographs of ms harlow and the vintage magazines containing harlow materialdollar_figure the non- harlow items consist of other items purchased in that were unrelated to ms harlow and were included in the calculation of the disputed deduction respondent argues that the harlow items were part of an extensive collection of harlow-related items that petitioner should not be permitted to depreciate respondent argues that the items in question have an indefinite economic life and are not properly subject_to a cost_recovery allowance petitioner wanted to build a research library on ms harlow that is so comprehensive it will be the first place a person interested in ms harlow will go for information petitioner purchased the vintage magazines and the harlow photographs to add 24petitioner failed to explain how groups in exhibit 34-j relate to the two categories of assets petitioner acquired in that are on petitioner’s schedule c depreciation schedule however we were able to discern how exhibit 34-j relates to petitioner’s depreciation schedule by totaling amounts for each group in exhibit 34-j and matching those totals with categories on petitioner’s depreciation schedule this exercise revealed that petitioner also spent dollar_figure on books for his projects and for general research and dollar_figure on three autographed photos of ms harlow but deducted depreciation with respect to these items on his schedule a itemized_deductions respondent made no adjustments to petitioner’s schedule a except a computational adjustment and has not raised any issue regarding the propriety of splitting cost_recovery deductions with respect to assets related to ms harlow between the schedule a and schedule c exhibit 34-j also reveals that petitioner spent dollar_figure on photos and dollar_figure on magazines mostly from the 1930s but it is not clear whether petitioner claimed any deductions with respect to these materials to his already extensive collection of harlow material petitioner did not prove that the photographs or magazines he acquired in and which he kept in archival sleeves are assets that have a limited economic useful_life or are subject_to wear_and_tear decay or obsolescence as a result of their use if any in petitioner’s schedule c activity moreover while the items that petitioner added to his harlow library related to one of petitioner’s existing projects petitioner has failed to demonstrate how those items were used in his businessdollar_figure the record simply establishes that petitioner acquired the items to add to his harlow library and that the items may be of use to petitioner in his schedule c activity if as and when he is able to market his idea for a harlow book film script or screenplay in short petitioner who bears the burden_of_proof see rule a has failed to convince us that the assets in question were not acquired primarily for his personal_use and enjoyment that the assets were actually placed into service in his schedule c activity or that the assets were depreciable or amortizable 25mr vieira credibly testified that he turned to petitioner’s research library in years before for photographs and quotes from the harlow period when he worked on his books about hollywood history and that he actually compensated petitioner to the tune of dollar_figure for the right to use some of petitioner’s harlow materials we infer from the record however that the items used were not the items acquired in and that are at issue here with respect to the non-harlow items designated general ongoing research petitioner did not introduce evidence to identify specifically what these items were or how the items were used if at all in his schedule c business activity at the same time the descriptions of items for example magazine or photo were generic and suggest that the purchased items could have been for amusement and entertainment rather than for business without meaningful evidence identifying with specificity the items purchased and their connection with petitioner’s schedule c business activity we simply cannot conclude that the items in question were properly depreciated or amortized during accordingly we sustain respondent’s disallowance of the cost_recovery deduction with respect to items designated general ongoing research see sec_262 sec_1_167_a_-1 income_tax regs the last group the uncategorized items included several items two admission tickets to a titanic exhibition a dollar_figure admission to the rose bowl swap meet a dollar_figure warranty for a tv a dollar_figure sears maintenance bill for a vacuum cleaner two admissions totaling dollar_figure to knott’s berry farm and dollar_figure for gym membership duesdollar_figure with the possible exception of the titanic exhibition 26petitioner asserts that none of those items were included in the schedule c deductions however the total for the category dues and periodicals appears to include these items and the total for that group on exhibit 34-j in turn equals the continued tickets there is no credible_evidence in the record that any of these expenditures were for business_assets that are depreciable with respect to the titanic exhibition tickets although petitioner credibly testified that he had sold documentary footage involving the titanic and that he continues to pursue his titanic project he did not show how the two admission tickets were related if at all to the project and whether the tickets were property for which a depreciation or amortization deduction was appropriate in addition the purchase of the second ticket suggests the exhibition visit was social and petitioner failed to offer any credible_evidence regarding the business_purpose of the visit we sustain respondent’s determination with respect to the deductions relating to assets acquired in expenditures with respect to assets purchased in a promotion goodwill and promotion goodwill ms vargas testified that the promotion goodwill category included self-promoting parties meals and other forms of building petitioner’s business petitioner testified generally continued cost_basis for the category vint magazine-library on the depreciation schedule 27the years in parenthesis indicate when petitioner acquired the particular category of assets the headings correspond to the lines on the depreciation schedule that the promotion category included the costs of flowers wine and things to build relationships on the basis of the very sparse and general record we are unable to conclude that the expenditures included in this category directly relate to petitioner’s business and are not personal or that the expenditures generated depreciable assets we sustain respondent’s determination with respect to this category b furniture and fixtures petitioner testified that in he purchased bookshelves and filing cabinets but he did not testify what these items were used for nor did he introduce any receipts to substantiate the nature of the items purchased the record contains no evidence to establish that petitioner used the items in his business and not as household_items accordingly we sustain respondent’s determination with respect to this category see sec_262 sec_1_167_a_-1 income_tax regs c salary promotion research library petitioner offered no testimony regarding these expenditure categories because petitioner did not prove what items he acquired or their relationship if any to his schedule c activity we sustain respondent’s determination with respect to these categories d books although petitioner did not introduce into evidence the list of books he purchased in he testified that his research library contains books about the titanic calamity jane the black donnellys and joan of arc when testifying about the expenditures categorized as books purchased in petitioner stated that this category includes all the books that i’ve just described earlier however the record contains no specifics on the assets purchased the record does not allow us to conclude that the books purchased were not for amusement and entertainment or for general personal_use accordingly we sustain respondent’s determination with respect to this category e artist supply research tapes theater photos dues and periodicals animation art research photo reference library petitioner testified with varying degrees of certainty what expenses were grouped under these categories with respect to artist supplies purchased in petitioner testified that the category includes items to generate design work characters and backgrounds petitioner also testified that the category photos reflecting items purchased during consisted of modern prints with the cost of up to dollar_figure and that the category research tapes theater reflecting expenditures made during included cds and films of the period and movie theater admissions i was going to the movie theater and studying what i’m watching with respect to the animation art category petitioner testified that the category may include cells from past animated features that he would use for his projects but he only loosely connected the category with the calamity jane projectdollar_figure petitioner’s testimony regarding dues and periodicals and animation art acquired in was even less certain he testified that dues and periodicals probably consisted of newspapers and magazines for his research library petitioner offered no evidence whatsoever to identify the items he purchased in and depreciated under the research photo category he testified only that the items in question were probably archival photographs acquired for specific projects petitioner testified that the items acquired in and categorized as reference library probably included magazine articles looseleaf articles or newspaper articles although petitioner described in detail his various projects and testified generally that his research library contains photographs books magazines audio materials and dvds related to his projects he did not introduce any evidence identifying the specific items he acquired and how those items related to his business on this sparse and unhelpful record we cannot find 28petitioner testified that animation art may be cells from past animated features that would be used in conjunction with something like calamity jane that these expenditures were directly related to petitioner’s business and were not personal expenses or costs of general amusement entertainment or recreation which ordinarily are not deductible see sec_262 sec_274 petitioner’s broad testimony that he was engaged in projects and that his research library contains materials related to them does not prove that the unknown assets included in these categories were business_assets that were properly depreciated or amortized because petitioner bears the burden_of_proof see rule a and failed to carry it we sustain respondent’s determination vi conclusion we have considered all remaining arguments made by the parties and to the extent not discussed above we reject those arguments as irrelevant moot or without merit to reflect the foregoing decision will be entered under rule


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc intl br3-plr-162881-01 date date legend taxpayer corporation a subsidiary b subsidiary c dear this is in response to a letter dated date from your authorized representative requesting rulings under sec_901 and sec_305 of the internal_revenue_code code the information submitted for consideration is substantially as set forth below taxpayer a domestic_corporation wholly owns corporation a a german corporation for which an election has been filed to treat it as a disregarded_entity for u s federal tax purposes corporation a owns all of the outstanding_stock of two german subsidiaries subsidiary b and subsidiary c the subsidiaries corporation a is a holding_company for its two subsidiaries its income is composed primarily of distributions from subsidiary b for u s federal tax purposes both of the subsidiaries are treated as corporations the three german corporations have elected to aggregate their taxable_income for german income_tax purposes in what is commonly referred to as an organschaft an organschaft is similar in concept to but not exactly the same as a u s consolidated_group for german tax purposes corporations are statutorily required to enter into a profit and loss transfer agreement as a condition for filing as an organschaft under this agreement the german subsidiaries are required to transfer their pre-tax profits and losses to the parent_corporation a this transfer cannot be waived because corporation a has a legal right to the pre-tax profits of the subsidiaries since each subsidiary is obligated to transfer all of its pre-tax profits to corporation a corporation a receives from each subsidiary the means to satisfy the related tax_liability corporation a is obligated to compensate the subsidiaries for any losses they incur even when corporation a itself has generated a loss each member of the organschaft calculates its losses independently for both tax and commercial purposes in the same manner as if no organschaft existed a net_operating_loss of one subsidiary can be used against the net operating_profit of corporation a and the other subsidiary each member of an organschaft files a separate company tax_return and computes its separate company taxable_income the parent of the organschaft includes the separate company taxable_income of its subsidiaries in the computation of its taxable_income the german statutory language technically requires the income of the subsidiaries to be attributed to the parent it is the parent company on which any german income_tax_liability is assessed for technical purposes and the parent is liable for remitting any_tax due on its subsidiaries’ profits the mutual rights and obligations arising from the required profit and loss transfer agreement must be disclosed in the commercial balance_sheet either as an account receivable or as an account payable between the parent and the subsidiaries the obligations under the profit and loss transfer agreement must be satisfied within a reasonable period of time in general a reasonable period of time is a period of months following the adoption of the annual accounts of the subsidiaries these obligations need not be satisfied in the form of a cash payment for example the obligations can be converted into a loan in addition it is permissible under german law for the parent to be obligated to return profits to the subsidiary in the form of a contribution_to_capital under the required profit and loss transfer agreement the parent of the organschaft has no specific claim against its subsidiaries for the income taxes associated with their income instead as noted above the parent has a right to all of its subsidiary’s pre-tax profits an amount which includes both the amount of the tax and the after-tax profits a subsidiary must transfer its pre-tax profits even if the organschaft’s total_tax liability is reduced by losses_incurred by other subsidiaries if a subsidiary must remit part or all of the income_tax_liability of the organschaft as a result of a parent’s default such subsidiary has a cause of action against the parent to recover such amount with respect to taxpayer all members of the organschaft have entered into a binding tax_allocation_agreement that in general allocates corporate income taxes among the members based on relative profits pursuant to a corporate resolution any payment by subsidiary b or c to corporation a in satisfaction of its payable under the organschaft’s profit and loss transfer agreement will be contributed to such corporation’s capital to the extent such payment exceeds its allocable share of the organschaft’s tax_liability determined in accordance with the tax_allocation_agreement pursuant to the resolution the subsidiaries are not required to issue additional shares of capital stock to corporation a the taxpayer’s german counsel has opined that were corporation a unable to pay part or all of the income_tax it is likely that the german tax authorities would be able to successfully collect the group’s entire tax_liability from subsidiary b or subsidiary c rather than merely collect each subsidiary’s portion of the organschaft’s tax_liability taxpayer’s german counsel has stated that the tax authorities’ legal_obligation to enforce the collection of the full tax claim might take precedence over any equitable principles that would otherwise limit the authorities’ ability to collect from the subsidiaries foreign_tax_credit analysis sec_901 of the code generally permits a taxpayer to elect to credit income taxes paid_or_accrued to a foreign_country against the taxpayer’s u s income_tax the sec_901 credit includes a credit for income taxes paid directly by a u s corporate taxpayer as well as income taxes deemed to have been paid indirectly by such a taxpayer under sec_902 sec_902 generally provides that a u s_corporation owning percent or more of the voting_stock of a foreign_corporation from which it receives dividends in any taxable_year shall be deemed to have paid the same proportion of such foreign corporation’s post-1986_foreign_income_taxes as the amount of such dividends determined without regard to sec_78 bears to such foreign corporation’s post-1986_undistributed_earnings sec_1_901-2 provides if foreign_income_tax is imposed on the combined income of two or more related_persons for example a husband and wife or a corporation and one or more of its subsidiaries and they are jointly and severally liable for the income_tax under foreign law foreign law is considered to impose legal liability on each such person for the amount of the foreign_income_tax that is attributable to its portion of the base of the tax regardless of which person actually pays the tax as stated above the taxpayer’s german counsel has opined that the german tax authorities would likely assess liability on and collect the entire tax from the subsidiaries if the parent_corporation a failed to remit the tax thus the liability of the members of the corporation a organschaft is substantially equivalent in practice to joint_and_several_liability legal liability for the german taxes therefore is to be determined under sec_1_901-2 and the german tax_liability is to be divided on a pro_rata basis among the members of the organschaft corporate analysis in 18_tc_396 aff’d per curiam 202_f2d_150 3rd cir subsidiaries of a consolidated_group made payments to their parent equal to the amount of tax that would have been due had the subsidiaries filed separate returns the court noted that the payment by a subsidiary of its allocable portion of the group’s tax_liability would not constitute a dividend the court held however that amounts in excess of the allocable portion of the actual liability constituted dividends accord 392_f2d_241 ct_cl revrul_73_605 1973_2_cb_109 relied on beneficial corp and dynamics corp to characterize payments between subsidiaries that were members of an affiliated_group filing consolidated_returns in the ruling each subsidiary whose hypothetical tax computed on a separate basis exceeded its share of the consolidated_tax_liability paid the excess_amount to the common parent along with its share of the consolidated_tax_liability the excess amounts were then paid_by the common parent to another subsidiary whose losses resulted in the reduced tax_liabilities of the profitable subsidiaries the ruling concluded that the payments by the subsidiaries in excess of their actual tax_liabilities are in substance dividends to their parent_corporation followed by contributions to the capital of the loss subsidiary sec_305 of the code provides that gross_income does not include the amount of any distribution of the stock of a corporation made by such corporation to its shareholder with respect to its stock except as otherwise provided in sec_305 of the code sec_305 of the code provides that sec_305 of the code does not apply and that the distribution will be treated as a distribution_of_property to which sec_301 applies if the distribution is at the election of any of the shareholders whether exercised before or after the declaration thereof payable either in stock or in property revrul_80_154 1980_1_cb_68 discusses the effect on the u s shareholders of a foreign_corporation of a shareholder resolution that declared a cash dividend and provided that the distribution was to be used to increase capital_investment in the corporation where no cash or stock was actually distributed the ruling contains the following analysis a resolution declaring a cash dividend raises the presumption that a cash dividend is intended however this assumption is rebutted when the corporate resolution ties up the cash dividend so effectively that the shareholders never receive it never exercise any control with respect to it and the dividend is used to pay for additional stock pursuant to a corporate resolution any payment by the subsidiaries to corporation a in satisfaction of their payables under the organschaft’s profit and loss transfer agreement will be contributed to such corporation’s capital to the extent such payment exceeds its allocable share of the organschaft’s tax_liability determined in accordance with the tax_allocation_agreement under revrul_80_154 sec_305 will apply to the foregoing transaction and the payment distribution will not be includible in the income of corporation a rulings based on the legal authorities cited above and on the facts and representations submitted including the fact that corporation a owns percent of the stock of subsidiaries a and b german law is considered to impose legal liability within the meaning of sec_1_901-2 on each member of the corporation a organschaft for the amount of german corporate_income_tax that is attributable to each member’s portion of the base of the tax as described in ruling regardless of which person actually remits the tax in determining the portion of the consolidated german tax_liability for which each member of the group is considered legally liable under sec_1 f the consolidated german liability of the group must be apportioned among the members of the group in accordance with the ratio which that portion of the consolidated_taxable_income measured under german law attributable to each member of the group having taxable_income bears to the consolidated_taxable_income the consolidated_taxable_income attributable to each member of the group is to be determined prior to the transfer of tax loss or profits by the subsidiaries to corporation a the portion of the german tax_liability attributable to corporation a’s income as determined under this ruling is creditable by taxpayer pursuant to sec_901 the pro_rata share of the german tax_liability attributable to the income of the subsidiaries as determined under this ruling is creditable by taxpayer pursuant to sec_902 the transfer for german tax purposes of a tax loss or profits by the subsidiaries to corporation a through the use of accounts_payable and accounts_receivable will be disregarded a payment from each of the subsidiaries to corporation a up to the amount of such subsidiary’s share of the organschaft’s taxes will not be treated as a dividend by such subsidiary any payment from the subsidiaries to corporation a in excess of such subsidiary’s share of the organschaft’s taxes will be treated as a dividend provided sufficient earnings_and_profits exist except to the extent a corporate resolution described in ruling below is in existence at the time of such payment if pursuant to a binding corporate resolution an amount of cash that would otherwise be paid to corporation a by the subsidiaries is instead required to be used to increase the capital of such subsidiary such amount will represent a distribution by the subsidiary of its common_stock to its shareholder and such distribution will not be includible in corporation a’s gross_income these rulings have effect only to the extent that the relevant german law remains substantially unchanged the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalties of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination this ruling is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent no opinion is expressed or implied regarding the application of any other provisions of the code or regulations a copy of this letter must be attached to any income_tax return to which it is relevant in accordance with the power_of_attorney on file in this office a copy of this letter is being sent to your authorized representative sincerely anne o’connell devereaux senior technical reviewer office of associate chief_counsel international


t c no united_states tax_court charles h davison and lessie b davison petitioners v commissioner of internal revenue respondent docket no filed date w a cash_basis partnership entered into an agreement in to borrow up to dollar_figure million from j j made an initial disbursement of dollar_figure pursuant to the loan agreement j applied dollar_figure of the initial disbursement as a credit for interest w owed to j on a previous loan pursuant to a subsequent modification of the loan agreement j agreed to advance dollar_figure to w to enable w to satisfy its current interest obligation to j j made a wire transfer of dollar_figure to w's bank account on date on date w made a wire transfer to j to satisfy w's current interest obligation the net effect of the dec transaction was to increase the principal_amount of w's loan from j by dollar_figure w claimed interest deductions of dollar_figure and dollar_figure and reported an ordinary_loss on its partnership return for r disallowed w's interest deductions determining that the interest had not been paid but merely postponed r adjusted ps' distributive_share of w's ordinary_loss accordingly held w is not entitled to interest deductions under sec_163 i r c a cash_basis borrower is not entitled to an interest_deduction where the funds used to satisfy the interest obligation were borrowed for that purpose from the same lender to whom the interest obligation was owed in those circumstances there has been no payment of interest rather payment has merely been postponed john s brown george p mair william a hazel matthew d schnall donald-bruce abrams and joseph l kociubes for petitioners charles w maurer jr for respondent opinion ruwe judge respondent determined deficiencies of dollar_figure and dollar_figure in petitioners' and federal income taxes respectively after a concession by respondent the issue for decision is whether white tail a general_partnership paid interest when it borrowed the funds used to satisfy its interest obligations from the same lender to whom the interest was owed petitioner charles h davison was a partner in white tail and petitioners claimed their distributive_share of the ordinary_loss reported by white tail on their federal_income_tax return background this case was submitted fully stipulated the stipulation of facts and the first supplemental stipulation of facts are incorporated herein by this reference petitioners resided in greenwich connecticut at the time they filed their petition petitioners were calendar_year cash_basis taxpayers petitioner charles h davison is a certified_public_accountant during he was head partner of the accounting firm peat marwick mitchell where he was associated with samuel j esposito and john l vitale who were also partners on date messrs davison esposito and vitale formed white tail a general_partnership organized under illinois law for the purpose of entering into the agricultural business of acquiring cultivating and selling farm properties each of the partners had a one-third interest in the profits losses and distributions of white tail white tail reported its income on a calendar_year basis using the cash_method_of_accounting on or about date white tail acquired approximately big_number acres of real_property located in hyde county north carolina and certain related personal_property on or about date white tail acquired approximately big_number acres of real_property located in hyde and tyrrell counties in north carolina in white tail realized dollar_figure in gross revenues from farming operations and incurred dollar_figure in operating_expenses exclusive of interest_expense in white tail realized dollar_figure in gross revenues from farming operations and incurred dollar_figure in operating_expenses exclusive of interest_expense white tail's credit arrangements with john hancock on date the john hancock mutual life_insurance co john hancock issued to messrs davison esposito and vitale a commitment to make a first mortgage loan on the white tail property in an amount up to dollar_figure million by a promissory note dated date white tail and john hancock established the credit arrangement contemplated by this dollar_figure million mortgage loan commitment subsequently on date john hancock issued to white tail a first mortgage loan commitment pursuant to which john hancock agreed to advance white tail a maximum amount of dollar_figure million the first mortgage loan 1this commitment preceded the actual formation of white tail and its acquisition of property 2in connection therewith white tail executed a deed_of_trust and security_agreement messrs davison esposito and vitale also executed a guaranty of note deed_of_trust and mortgage in the amount of dollar_figure million with the maximum individual liability of each guarantor limited to one-third of this amount in addition brad hill farms brad hill another partnership of messrs davison esposito and vitale executed a mortgage of certain illinois real_property as further security for the dollar_figure million promissory note white tail and john hancock modified their agreement with a modification of promissory note and deed_of_trust and security_agreement dated date commitment required that white tail use a portion of the funds borrowed to retire existing indebtedness to john hancock and envisioned that additional_amounts would be advanced to white tail up to the aggregate principal_amount of dollar_figure million by a promissory note dated date white tail and john hancock established the john hancock credit arrangement the credit arrangement as contemplated by the first mortgage loan commitment this promissory note required white tail to pay interest on its borrowings at an annual rate of dollar_figure percent payable every january commencing date the promissory note also entitled john hancock to percent of white tail's net farm income as well as percent of white tail's net profits from land sales pursuant to the establishment of the credit arrangement john hancock made initial disbursements on date totaling dollar_figure a portion of the dollar_figure 3the first mortgage loan commitment stated that white tail's existing indebtedness to john hancock was dollar_figure million 4in connection with the execution of the date promissory note and the establishment of the credit arrangement white tail executed a deed_of_trust and security_agreement and an option agreement moreover each of white tail's partners executed a guaranty of note deed_of_trust and mortgage the guaranty of note provided that each partner guaranteed the payment of one-third of the amount owed under the credit arrangement up to a maximum amount of dollar_figure million brad hill also executed a guaranty of note deed_of_trust and mortgage the deed_of_trust and security_agreement was amended by an amendment to deed_of_trust and security_agreement dated date consisted of a credit to white tail's prior loan account with john hancock for dollar_figure to pay off the principal that white tail owed pursuant to the prior credit arrangement and a credit to white tail's prior loan account for dollar_figure to satisfy the interest obligation that had accrued on the prior loan the credit arrangement required white tail to make an interest payment on date the amount of interest due was dollar_figure pursuant to the terms of the credit arrangement one-half of the interest could be borrowed from john hancock the credit arrangement also called for a principal payment of dollar_figure on the same date white tail needed to satisfy the requirements set forth in the first mortgage loan commitment in order to become eligible to make additional borrowings under the credit arrangement these additional borrowings were characterized as land development and operating funds borrowings under the terms of the first mortgage loan commitment the disbursement for operating funds was subject_to the following provision if the borrower's net farm income is insufficient to fund the interest accrued on the loan contemplated herein from date of closing to date john hancock shall disburse sufficient proceeds of this loan to fund said interest shortage provided however that the amount of said disbursement for operating funds shall not exceed of the actual accrued interest during said period and provided further that john hancock's said disbursement for such interest shortage shall not be disbursed until borrower has advanced its portion of the actual accrued interest similar provisions covered the disbursement of operating funds for the credit arrangement remained in effect from date through date white tail's business was unprofitable and in date mr esposito requested that john hancock modify the terms of the credit arrangement in order to prevent a default on date john hancock mailed a letter of agreement letter agreement to white tail c o mr esposito the letter agreement states gentlemen reference is made to the enclosed vote page three approved date by our agricultural investment committee and approved today by our committee of finance in which vote we have authorized the modification of the legal papers evidencing and securing the above referenced loan said modification will capitalize certain interest due from you on date and will defer certain principal due from you on the same date all as set forth in said vote said modification will further increase john hancock's participation in the property's defined operating income and in the security's appreciation also all as set forth in said enclosed vote you have asked us to enter into this letter of agreement with you this week in advance of our referrel sic to counsel and his preparation of the definitive documentation in order to prevent a default in your payment due_date 5see supra p if this letter of agreement is to become effective you must sign the enclosed copy hereof and return the same to me at the home_office so that the same is received by me prior to date attached to the letter agreement were the minutes from a date meeting of john hancock's agricultural investment committee stating that the committee voted to accept the following modification of the credit arrangement to capitalize dollar_figure of the dollar_figure interest due_date and to defer the dollar_figure principal installment due_date until date the final maturity under fml farm mortgage loan white tail farm big_number acres secured_by a first mortgage loan in north carolina and illinois in consideration of white tail farm providing john hancock participation as follows between date and date of net farm income and of the net profit from land sales and between date and date of net farm income and of the net profit from land sales over value assigned to land rather than of net farm income and of the net profit from land sales as originally provided mr esposito signed the letter agreement on behalf of white tail on date john hancock made a wire transfer of dollar_figure to white tail's account at the american national bank and trust co of chicago american national this transfer increased the amount white tail owed to john hancock by dollar_figure this amount is reflected as a deposit into the american national account on date on date white tail made a wire transfer of dollar_figure to john hancock representing dollar_figure of principal and dollar_figure in interest due under the credit arrangement the purpose of the dollar_figure advance from john hancock was to provide white tail with sufficient funds to satisfy the interest due john hancock on date under the terms of the credit arrangement as modified white tail's general ledger showed that its bank account at american national as of date was overdrawn with a negative balance of dollar_figure on their federal_income_tax return petitioners reported an ordinary_loss of dollar_figure as their distributive_share of the dollar_figure ordinary_loss reported by white tail on its u s partnership return of income form_1065 for on date respondent issued a notice_of_deficiency adjusting petitioners' distributive_share of the ordinary_loss reported by white tail in particular respondent disallowed the interest 6there is no explanation of why the dollar_figure principal payment was not deferred in accordance with the modification of the credit arrangement 7this amount includes outstanding checks that had been written on but had not yet cleared white tail's american national account this amount is also shown as a liability on white tail's u s partnership return of income form_1065 8respondent also adjusted petitioners' medical_expense_deduction for in the amount of dollar_figure and their investment continued deductions for amounts that white tail claimed to have paid to john hancock on may and date in the respective amounts of dollar_figure and dollar_figure respondent adjusted petitioners' distributive_share of white tail's ordinary_loss accordingly discussion before we analyze the transactions in issue it is appropriate to state some general principles with respect to interest deductions sec_163 a generally permits a deduction for all interest_paid or accrued within the taxable_year on indebtedness for cash_basis taxpayers payment must be made in cash or its equivalent 429_us_569 283_us_140 80_tc_1174 the delivery of a promissory note is not a cash_equivalent but merely a promise to pay helvering v price continued tax carryback to in the amount of dollar_figure both of these items are computational adjustments 9respondent also disallowed an interest_deduction for dollar_figure that was borrowed from john hancock and paid to j h cochrane respondent now concedes that white tail is entitled to a deduction for its interest payment of dollar_figure to j h cochrane 10unless otherwise indicated all section references are to the internal_revenue_code in effect for the taxable years in issue and all rule references are to the tax_court rules_of_practice and procedure u s 42_tc_601 where a lender withholds a borrower's interest payment from the loan proceeds the borrower is considered to have paid interest with a note rather than with cash or its equivalent and therefore is not entitled to a deduction until the loan is repaid menz v commissioner supra pincite 6_tc_452 affd 158_f2d_342 7th cir on the other hand where a taxpayer discharges interest payable to one lender with funds obtained from a different lender the interest on the first loan is considered paid when the funds are transferred to the first lender menz v commissioner supra 77_tc_582 with these general principles in mind we proceed to look at the specific transactions in issue because the december transaction presents the more difficult issue we address it first under the terms of the credit arrangement an interest payment and a principal installment were due from white tail on date in the credit arrangement john hancock had agreed to lend white tail up to percent of the interest that was due so long as white tail was able to provide the remaining percent in date mr esposito one of white tail's general partners approached john hancock and requested that it agree to modify the credit arrangement with respect to the required_interest payment in order to prevent a default by white tail in the letter agreement dated date it was agreed that john hancock would modify the credit arrangement so as to capitalize dollar_figure of the dollar_figure interest due from white tail and defer the due_date for the principal installment until january dollar_figure in the original credit arrangement john hancock had already agreed to lend one-half of the interest due on date the effect of the modification was that all the interest due to john hancock on date would be borrowed from john hancock on date john hancock wired dollar_figure to white tail's account at american national this increased the amount white tail owed john hancock by dollar_figure on date white tail wired john hancock dollar_figure which john hancock reflected as a satisfaction of white tail's date interest obligation of dollar_figure plus a principal payment of dollar_figuredollar_figure 11we construe the term capitalize as used in the letter agreement and the minutes to mean that the principal of the loan would be increased by the amount of interest due on date 12the letter agreement dated date and the attached minutes indicate that john hancock was going to allow white tail to defer the principal payment of dollar_figure nevertheless on date john hancock billed white tail for both principal and interest and the wire transfer of dollar_figure includes a principal payment of dollar_figure the record contains no explanation for this the purpose of john hancock's dollar_figure advance to white tail on date was to provide white tail with sufficient funds to satisfy the interest due john hancock on date petitioners argue that white tail paid this interest when it made the wire transfer to john hancock on date respondent contends that interest has not been paid but merely postponed and consequently white tail is not entitled to a deduction under sec_163 on brief petitioners place particular reliance on prior decisions of this court in which the deductibility of interest_paid to a lender with funds borrowed from the same lender turns on whether the borrower exercised unrestricted control_over the funds borrowed petitioners argue that they are entitled to a deduction pursuant to sec_163 because white tail possessed unrestricted control of the dollar_figure wired from john hancock to white tail's account at american national on date the concept of unrestricted control in cases of this nature had its origin in 8_tc_47 in burgess a cash_basis taxpayer originally borrowed dollar_figure on date just prior to the due_date of his interest payment the taxpayer borrowed an additional dollar_figure from the same lender deposited the lender's check in the taxpayer's checking account and commingled the dollar_figure with other funds in the account on date the taxpayer drew a check on this account in the amount of dollar_figure to cover dollar_figure of interest due on the original loan plus dollar_figure of prepaid_interest on the dollar_figure loan at the time the taxpayer's check was drawn the taxpayer had dollar_figure in his account in addition to the dollar_figure borrowed on date in a court-reviewed opinion we allowed the deduction we rejected the commissioner's argument that the taxpayer had simply substituted a note in place of the interest payable we found that the taxpayer did not apply for the loan for the sole purpose of obtaining funds to pay interest and the lender did not grant the loan for that exclusive purpose we also found that the taxpayer had several bills that were due needed sufficient funds to pay them as well as the interest and commingled the loan proceeds with other funds in his account causing them to lose their identity as a result we found that the loan proceeds could not be traced to the payment of interest id pincite six judges dissented from the majority's holding they believed that the facts demonstrated that the taxpayer borrowed the dollar_figure for the purpose of paying interest they believed that the substance of what occurred was no different than where a taxpayer simply executes a note to the lender in satisfaction of the current interest obligation in burgess v commissioner supra the purpose of the second loan was obviously an important factor however our subsequent opinions relying on burgess began to focus mostly on whether the borrower acquired possession or control_over the proceeds of the second loan this was later referred to as unrestricted control see menz v commissioner t c pincite in 63_tc_556 affd on other grounds 533_f2d_768 2d cir a cash_basis taxpayer borrowed dollar_figure from a bank on date pursuant to negotiations that preceded the loan agreement dollar_figure million of these proceeds was deposited into the taxpayer's account at a second bank prior to this deposit the taxpayer's other funds in the account totaled dollar_figure on date pursuant to the negotiated agreement between the lender and the taxpayer dollar_figure was transferred from the taxpayer's account back to the lender for year's prepaid_interest on the loan we concluded that the facts in burck were within the scope of our decision in burgess v commissioner supra and allowed the interest_deduction in reaching this decision we relied primarily on the fact that the loan proceeds were commingled with the other funds in the taxpayer's account we also pointed out that the taxpayer owned other assets from which the interest could have if need be been prepaid even though the taxpayer's bank account contained insufficient funds to pay the interestdollar_figure 13the court considered the taxpayer's nonliquid assets in making this determination even though there was no indication that these assets could have been liquidated to make the required_interest prepayment in date see 63_tc_556 n affd on other grounds 533_f2d_768 continued we also considered the fact that prepayment of the dollar_figure in interest was an integral part of the loan agreement because the bank would not have made the loan without it it was clear that dollar_figure of the loan proceeds was advanced for the purpose of paying interest to the lender faced with essentially the same fact pattern in 70_tc_240 revd and remanded 655_f2d_980 9th cir we followed the reasoning and result of burck v commissioner supradollar_figure responding to the commissioner's argument that the borrowers never had unrestricted control_over the loan proceeds we stated we have rejected that same argument where the lender gave up control of the borrowed funds the funds were commingled with the taxpayer's own funds and then the commingled funds were used to prepay interest 8_tc_47 63_tc_556 affd 533_f2d_768 2d cir wilkerson v commissioner supra pincite in wilkerson without the loan the borrowers did not have sufficient funds with which to satisfy their interest obligations prior to receipt of the loan proceeds used to satisfy their interest obligations the borrowers had checking continued 2d cir 14in 70_tc_240 revd and remanded 655_f2d_980 9th cir we stated that the burgess and burck cases are not meaningfully distinguishable from the facts before us account balances of dollar_figure and dollar_figure respectively while their respective interest payments were approximately dollar_figure in response to the commissioner's argument that there was insufficient commingling we stated the partnerships here acquired control of the loan proceeds as evidenced by their deposit in the partnership checking accounts outside the lender's domain that the partnerships exercised their control_over the funds for only a brief period of time does not convert the transactions into discounted loans id pincite in wilkerson unrestricted control appears to mean unrestricted physical or mechanical control in the sense that there were no physical or mechanical restraints on the borrower's ability to withdraw borrowed funds for a purpose other than paying interestdollar_figure used in this sense unrestricted control ignores the fact that the borrower may have obligated himself to use the loan proceeds to pay interest to the lender as a precondition to the loan and also ignores the fact that failure to use loan proceeds for the purpose of satisfying a current interest obligation would result in a default and likely foreclosure proceedings two courts of appeals have rejected this application of an unrestricted control rule wilkerson v commissioner f 2d 15we found as a fact that the partnerships had unrestricted physical control_over the loan advances when they were deposited to the partnerships' accounts wilkerson v commissioner supra pincite 9th cir 631_f2d_1182 5th cir en_banc dollar_figure in battelstein the lender agreed to make advances to cover the taxpayers' quarterly interest payments on a dollar_figure million loan the taxpayers never paid interest except by way of these advances the lender notified the taxpayers each quarter of the amount of interest that was due the taxpayers would then send a check for this amount and the lender would send the taxpayers a check for an identical amount the court_of_appeals for the fifth circuit concluded that the check exchanges between the lender and borrower were plainly for no purpose other than to finance the taxpayers' current interest obligations and therefore denied the interest_deduction in rejecting the taxpayers' reliance on the fact that actual checks were exchanged the court_of_appeals stated 16in addition judges of two other courts of appeals although not faced with the issue have in dicta criticized our application of the rule see 533_f2d_768 2d cir 267_f2d_127 1st cir affg 30_tc_1178 in burck v commissioner supra the court_of_appeals for the second circuit affirmed our decision but it did not consider the issue presented here in a portion of the opinion where he was writing for himself only judge oakes noted that he disagreed with our decision permitting an interest_deduction id pincite n judge oakes viewed the transaction at issue as having the effect of creating a 'discounted loan ' and he concluded that there was no payment of interest by taxpayer within the meaning of sec_163 until actual repayment of the loan id judge oakes further noted his agreement with the dissenting opinion in 8_tc_47 id see also goodstein v commissioner supra pincite noting in dicta that it considers the reasoning of the dissent in burgess v commissioner supra to be the more persuasive in ignoring these exchanges we merely follow a well- established principle of law viz that in tax cases it is axiomatic that we look through the form in which the taxpayer has cloaked a transaction to the substance of the transaction see eg 613_f2d_518 5th cir 399_f2d_652 5th cir citing cases as the supreme court stated some years ago in 302_us_609 58_sct_393 82_led_474 a given result at the end of a straight path is not made a different result because reached by following a devious path u s pincite s ct pincite the check exchanges notwithstanding the battelsteins satisfied their interest obligations to gibraltar by giving gibraltar notes promising future payment the law leaves no doubt that such a surrender of notes does not constitute payment for tax purposes entitling a taxpayer to a deduction id pincite the court_of_appeals rejected the taxpayers' reliance on 8_tc_47 the court_of_appeals determined that even if burgess constituted good law it was limited to cases where the purpose of a subsequent loan was not apparent ie whether it was to finance interest payments on a previous loan for which deductions are being claimed or whether it was to fulfill some other unrelated objective the court_of_appeals held that if the second loan was for the purpose of financing the interest due on the first loan then the taxpayer's interest obligation on the first loan has not been paid as sec_163 requires it has merely been postponed battelstein v irs supra pincite in wilkerson v commissioner f 2d pincite the court_of_appeals relied on battelstein v irs supra and denied the interest_deduction because a portion of the loan proceeds was specifically earmarked for the purpose of paying the interest due the court_of_appeals stated that the fact that the loan proceeds were run through the taxpayers' bank account in a transaction intended to take not more than one business_day does not affect the substance of the transaction wilkerson v commissioner supra pincite moreover the court_of_appeals explained that a careful reading of 8_tc_47 indicates that it involved two separate loan transactions in which the proceeds of the second loan were not earmarked for the purpose of payment of interest on the first loan id shortly after the reversal in wilkerson v commissioner supra we acknowledged the confusion in this area brought about by the disparity of results among cases of similar economic impact menz v commissioner t c pincite in menz we summarized this court's previous application of the unrestricted control test as follows where a lender gives up control of borrowed funds the funds are commingled with the taxpayer's other funds in an account at an institution separate from the lender and the interest obligation is satisfied with funds from that separate_account there has been a payment of interest under sec_163 id pincite citations omitted 17despite this test for determining unrestricted control consideration of the borrower's purpose for acquiring the continued in menz we found that the taxpayer had not received unrestricted control_over the funds borrowed for the purpose of paying interest we based this conclusion on the following facts the loan to the borrower the deposit into the borrower's checking account and the retransfer of the funds to the lender were all simultaneous the remaining funds in the borrower's account with which it could have paid the interest in question were de_minimis the loans were made solely for the purpose of paying the interest owed to the lender the borrowed funds were easily traceable through the borrower's account to the asserted interest payments and a wholly owned subsidiary of the lender was a 1-percent general_partner of the borrower and possessed approval power over all the borrower's major transactions the fifth factor is the only one that was not present in wilkerson the 1-percent partner did not have signatory authority over the bank account into which the borrowed funds were deposited menz v commissioner supra pincite nevertheless we found that the borrower lacked unrestricted control because the 1-percent general_partner of the borrower was controlled by the lender and could have terminated the borrower's existence if it had failed to use the borrowed funds to satisfy interest obligations owed to continued additional funds was never completely disregarded see 80_tc_1174 ndollar_figure the lender we found that the 1-percent partner's control_over the future of the partnership was too fundamental and significant to conclude that the partnership's control_over the funds in its account was unrestricted id pincite we think that similar fundamental and significant factors restricted white tail's control_over the dollar_figure that john hancock wired to white tail's account on date white tail had specifically agreed to borrow this amount to satisfy its interest obligation in order to prevent a default use of the funds for any other purpose would have breached the terms of its agreement with john hancock and would have resulted in white tail's default and a likely end to its business operationsdollar_figure in wilkerson we chose not to consider the impact of a default and its consequences on whether the borrower had unrestricted control_over funds that it borroweddollar_figure see wilkerson v commissioner t c pincite however in menz 18the existence of such an agreement has been held to restrict the borrower's control_over borrowed funds see franco v commissioner tcmemo_1992_577 19as we stated in menz v commissioner t c pincite- we chose not to address what impact a default would have had and found as fact that the borrower had been given unrestricted physical control_over the loan advance at the time it was deposited in the borrower's account t c pincite on that basis we held that the taxpayer's situation in wilkerson was not meaningfully distinguishable from the burgess and burck cases and found that there had been the requisite payment of interest we expanded our analysis and considered factors beyond physical control_over the borrowed funds similarly in this case we cannot ignore the reality that a borrower who borrows funds for the purpose of satisfying an interest obligation to the same lender in order to avoid a default does not have unrestricted control_over the borrowed funds in any meaningful sense in light of our expanded view of the considerations that must be taken into account in determining whether a borrower has unrestricted control_over borrowed funds our earlier opinions in burgess burck and wilkerson have been sapped of much of their vitalitydollar_figure the issue before us arises when a borrower borrows funds from a lender and immediately satisfies an interest obligation to the same lender in order to determine whether interest has been paid or merely deferred it is first necessary to determine whether the borrowed funds were in substance the same funds used to satisfy the interest obligation whether the relevant transactions were simultaneous whether the borrower had other funds in his account to pay interest whether the funds are traceable and whether the borrower had any realistic choice to use the borrowed funds for any other purpose would all be 20recent opinions indicate that an expanded unrestricted control test will likely produce the same result as the test applied in the fifth and ninth circuit courts of appeals see alexander v commissioner tcmemo_1995_334 blumeyer v commissioner tcmemo_1992_647 franco v commissioner supra relevant to this issue once it is determined that the borrowed funds were the same funds used to satisfy the interest obligation the purpose of the loan plays a decisive role in light of the foregoing analysis we hold that a cash_basis borrower is not entitled to an interest_deduction where the funds used to satisfy the interest obligation were borrowed for that purpose from the same lender to whom the interest was owed this test is consistent with our traditional approach of characterizing transactions on a substance-over-form basis by looking at the economic realities of the transaction we agree with the courts of appeals in wilkerson and battelstein that there is no substantive difference between a situation where a borrower satisfies a current interest obligation by simply assuming a greater debt to the same lender and one where the borrower and lender exchange checks pursuant to a plan whose net result is identical to that in the first situation in both situations the borrower has simply increased his debt to the lender by the amount of interest the effect of this is to postpone rather than pay the interest in the instant case it is clear that the purpose of the dollar_figure advance on date from john hancock to white tail was to provide white tail with funds to satisfy its interest obligation to john hancock white tail's general_partner had requested modification of the original credit arrangement so that the entire amount of interest could be borrowed from john hancock in order to prevent a default on the interest obligation in the letter agreement between white tail and john hancock both borrower and lender agreed that the dollar_figure advance would increase white tail's loan and that it would be used to satisfy the current interest obligation checks were exchanged within a 2-day period to effect the transaction the effect was to increase the amount of white tail's principal loan obligation to john hancock by the amount of interest due the fact that the loan proceeds were run through white tail's bank account does not affect the substance of the transaction wilkerson v commissioner f 2d pincite it follows that white tail a cash_basis partnership is not entitled to a deduction for interest_paid the other transaction in issue also involves a situation where an interest obligation was satisfied by borrowing funds from the original lender on date following the establishment of the credit arrangement john hancock advanced dollar_figure to white tail of this amount john hancock applied dollar_figure to unpaid interest owed under the terms of a previous loan to white tail john hancock did this by crediting white tail's prior loan account to show that white tail's interest obligation in the amount of dollar_figure had been satisfied john hancock simultaneously increased the principal_amount due from white tail under the new credit arrangement as stated above we hold that interest is not deductible under the cash_method_of_accounting where the funds used to satisfy the interest obligation were borrowed for that purpose from the same lender to whom the interest obligation was owed that is clearly what happened on date when pursuant to the terms of the credit arrangement john hancock credited white tail's prior loan account for interest due and simultaneously increased the principal due on white tail's new loan for the same amount petitioners argue that the dollar_figure should be considered as interest_paid because the credit arrangement and the loan from john hancock were bona_fide separate loans with different interest rates and terms and different security arrangements under our holding the fact that funds used to satisfy an interest obligation to a lender are borrowed from the same lender in a second loan is irrelevant indeed this court has previously rejected the argument presented by petitioners in cleaver v commissioner t c pincite we stated where a taxpayer on the cash_basis who is indebted on a note for past due interest borrows from his creditor an amount in excess of this past due interest on a second note and the creditor gives to the taxpayer the principal_amount of the second note less the amount of past due interest on the first note and marks this interest_paid we have held that no cash payment has been made which would warrant a deduction see also nat harrison associates inc v commissioner t c pincite interest withheld by a lender from loan proceeds is nothing more than a promise to pay in the future and does not constitute a payment for purposes of sec_163 menz v commissioner t c pincite6 67_tc_621 cleaver v commissioner supra pincite based on the foregoing analysis the interest deductions claimed by white tail on its return in the amounts of dollar_figure and dollar_figure are not allowable and we sustain respondent's disallowance of the corresponding deductions that petitioners claimed as their distributive_share of partnership loss decision will be entered under rule