Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Feb 20, 1951
16 T.C. 407 (U.S.T.C. 1951)

Docket No. 23368.



Jacob Rabkin, Esq., for the petitioner. Sheldon V. Ekman, Esq., for the respondent.

Jacob Rabkin, Esq., for the petitioner. Sheldon V. Ekman, Esq., for the respondent.

Cash payment by motion picture company for release of part of petitioner's rights against it resulting from royalty contract covering play of which petitioner in the course of his business had been the producer, held, ordinary income not capital gain; held, further, deduction for expenses incurred in petitioner's business as a theatrical producer allowed.

Petitioner assails respondent's determination of a deficiency of $11,548.64 in income and victory tax for 1943. The year 1942 is involved under the Current Tax Payment Act of 1943. One adjustment is not contested and concessions of the parties have disposed of one issue. The remaining issues are whether certain income, arising out of a transaction involving motion picture rights, constituted ordinary income or capital gain, and whether respondent correctly disallowed certain deductions claimed as business expense Some of the facts were stipulated.


The stipulated facts are hereby found.

Petitioner filed his returns with the collector of internal revenue for the third district of New York.

Petitioner, a theatrical producer, has produced approximately 25 stage plays during a period of about 20 years, his activities consisting of choosing plays for production, bringing together playwrights, actors, and other professional participants and supervising financial and business arrangements. He operated under agreements granting to the producer either part ownership of the motion picture rights or participation rights to a share of the proceeds of sale of motion picture rights. Motion picture rights to about three-fourths of the plays produced by petitioner have been sold, and he has received sums of money, either from the purchaser or author, resulting from the sale of those rights.

On February 17, 1941, petitioner entered into a ‘Dramatic Production Contract‘ with Lillian Hellman whereby she leased to him the exclusive right to produce and present, in the United States and Canada, the stage production of a play written by her which was later named ‘Watch on the Rhine.‘ The contract provided for royalties to her of 10 per cent of all gross weekly box office receipts. It further provided that petitioner should be entitled to receive a specified share of moneys resulting from the proceeds of certain subsidiary rights, 40 per cent being the agreed percentage with respect to motion picture rights.

The contract was made subject to the provisions of the ‘Minimum Basic Agreement‘ negotiated by The Dramatists' Guild with theatrical producing managers, which had been signed by petitioner, and which provided, among other matters: That petitioner should rehearse, produce and present the play; that if the play were produced in Manhattan, and should run for 3 weeks' consecutive performance, then petitioner should have ‘the exclusive lease for first-class production in United States for so long as he shall continue so to produce the play for at lease seventy-five (75) times in any one year‘; that ‘The author shall retain for his sole benefit, complete title, both legal and equitable, in and to all rights whatsoever (including, but not by way of limitation, motion picture rights * * * )‘; that 3 weeks after the initial performance motion picture rights might be sold or leased free of any claim by petitioner and without the latter's consent; that petitioner's objections to a proposed motion picture release date should be given due consideration; that petitioner should have ‘no right, title or interest, legal or equitable, in the motion picture rights‘ other than the right to receive his share of the proceeds; that petitioner should have ‘no recourse, in law or equity, against any purchase or lessee of such rights,‘ his only recourse, if aggrieved, to be against the author; that no claim by petitioner should constitute a cloud on the title to those rights, and that if petitioner should present the play for 3 weeks' consecutive performances in Manhattan, pay all royalties when due, and otherwise duly comply with all the terms of the agreement, then petitioner should receive the agreed percentage from the sale or lease of the subsidiary rights.

On March 4, 1941, petitioner assigned all his rights in the contract with Hellman to the Watch on the Rhine Company, a partnership, hereinafter called petitioner's Company, in which he owned 90 per cent and Kermit Bloomgarden owned 10 per cent interests. The assignment conformed with petitioner's practice, in the production of plays, to form a partnership or corporation, having as its sole purpose the production of a single play. Petitioner's Company produced the play, its production being the only activity of the Company. The play ran in Manhattan from April 1941 to February 1942, and thereafter played on the road, closing in February 1943.

Subsequently Hellman consulted with petitioner regarding a sale of the motion picture rights to Warner Bros. Pictures, Inc., hereinafter called Warner Bros. On December 30, 1941, Hellman entered into a contract with Warner Bros. warranting that she was the sole owner of all motion picture rights in the play, and selling those rights for $150,000 to be paid in installments in 1942, 1943 and 1944, plus 15 per cent of the gross motion picture receipts in excess of a special sum.

Thereafter Hellman consulted with petitioner concerning an offer by Warner Bros. to substitute additional fixed cash payments for the percentage arrangement. Warner Bros. desired petitioner to be a party to such an agreement. He agreed with the understanding that his Company's share would be paid first.

Thereafter Hellman consulted with petitioner concerning an offer by

On December 27, 1943, an agreement was entered into between Lillian Hellman and petitioner's Company, as parties of the first part, and Warner Bros. as party of the Second part. Hellman released her rights to 15 per cent of the motion picture gross receipts under the contract of December 30, 1941. The agreement recited the representation of the parties of the first part that petitioner's Company was entitled to 40 per cent of all sums payable under the contract of December 30, 1941; stated that petitioner's Company had approved that contract, and that it represented that it had not assigned any of its rights thereunder; stated that two fixed cash installments remained due under the lump-sum payment provision of that contract, and recited the desire of Warner Bros. to be relieved of its obligations under the percentage arrangement. In lieu of a percentage of gross receipts, Warner Bros. agreed to pay a consideration of $175,000 two sums of $33,775 each to be paid to petitioner's Company on December 1, 1943 and June 1, 1944 and other installments to be paid to Hellman's representative. Petitioner's Company consented to and approved the arrangements and undertakings thus made. The agreement provided that the parties of the first part released Warner Bros. from all claims relating to the motion picture, except the obligations to pay the cash installments specifically provided in the two agreements.

Warner Bros. produced a motion picture based upon the play, and paid sums pursuant to the agreements. Warner Bros. employed petitioner as a director for this and another motion picture.

During 1942 and 1943 an accounting firm kept petitioner's books of account and prepared his tax returns. The firm maintained a cash book in which entries were made periodically in the regular course of business and within a reasonable time after the recorded transactions. The entries were taken from check books maintained by petitioner's office, in which all expenditures by check were recorded. The accounting firm, consulting with petitioner when it deemed necessary, separated business from personal expenses, charging the latter to petitioner's personal account. Cash book entries were summarized in work sheets which were prepared annually by the accounting firm and kept as part of their permanent records. Petitioner's tax returns were prepared from the work sheets.

During each year petitioner made cash outlays for both business and personal expenses. Petitioner's occupation as a producer required him to make frequent trips to view amateur theatrical productions, and involved the cultivation of playwrights, actors, designers, and other theatre people. A portion of petitioner's cash outlays were due to travel, entertainment, and other business expenses. Cash withdrawals were charged to petitioner's personal account in the cash book. At the end of each year petitioner and his accountant estimated the amount of cash expenditures to be allocated as business expense.

Petitioner's tax return for 1942 showed total gross income of $117,223.11, and claimed an expense deduction for his personal theatrical business of $13,757.66, which included an item for traveling, entertainment and business expense totaling $4,243.72, of which the sum of $2,600 represented estimated cash outlays. Petitioner's return for 1943 showed total gross income of $61,037.84, and reported as long term capital gain the amount of $29,645.10, representing one-half of petitioner's share of proceeds received by petitioner's Company under the agreement of December 27, 1943, with Warner Bros., and the 1943 return claimed an expense deduction for his personal theatrical business of $12,331.88, which included an item for traveling, entertainment, and miscellaneous expense totaling $7,331.54, of which the sum of $5,200 represented estimated cash outlays.

In a notice of deficiency mailed on March 2, 1949, respondent determined that petitioner's share of proceeds received in 1943 under the agreement of December 27, 1943, constituted ordinary income. Respondent disallowed $3,000 of the claimed 1942 deduction of $13,757.66 and disallowed $4,000 of the claimed 1943 deduction of $12,331.88 on the ground that they had not been substantiated.

Petitioner paid expenses of his personal theatrical business totaling $13,757.66 in 1942 and $12,331.88 in 1943.


OPPER, Judge:

The characterization of petitioner's contract rights as ‘property‘ contributes little to resolving whether petitioner's arrangement with Warner Bros. resulted in capital gain or ordinary income. A legal right or claim can be received under such circumstances that its fair market value constitutes ordinary income, regardless of its character, as for example, when it is the form in which payment for personal services is received, Regulations 111; section 29.22(a)-3, and by the same token such a claim may become income not when it is received, but when it is converted into cash. Helvering v. Eubank, 311 U.S. 122; Shuster v. Helvering (CCA-2), 121 Fed.(2d) 643.

In our view the latter description of the underlying events most nearly conforms with the present record. Petitioner's power to share in the proceeds of the successful production of ‘Watch on the Rhine‘ was due in the first instance to his contribution of services as its producer. See Irving Berlin, 42 B.T.A. 668. And the facts that a part of the proceeds originally took the form of a share in royalties for a license to employ the material in a motion picture, see Commissioner v. Strauss (CCA-2), 169 Fed.(2d) 441, and that eventually petitioner received a lump sum in substitution, fail to deprive the whole transaction of that basic character. Shuster v. Helvering, supra. Nor can it be said that when the payment was received in the tax year, it was in exchange for a complete assignment of all copyright interests even if that should be material, nor that the agreement with Warner Bros. did not deal with subject matter in the nature of petitioner's stock in trade. Goldsmith v. Commissioner (CCA-2), 143 Fed. (2d) 466, certiorari denied, 323 U.S. 774.

The specific details were, as our findings show, somewhat complicated. Under his contract with the playwright, petitioner became entitled to a share of the proceeds of any sale of motion picture rights she might arrange, his objections to a proposed motion picture release date to be given due consideration. The playwright's first contract with Warner Bros. provided for the payment of cash installments in fixed amounts as well as a percentage of motion picture receipts. Before all fixed installments had been paid and prior to the release of the picture, Warner Bros. and the playwright entered into a subsequent agreement which substituted additional cash payments in fixed installments for the percentage arrangement. This agreement stated that petitioner's Company had approved the first contract and consented to the substitute arrangement. Warner Bros. desired petitioner to be a party to this agreement, and he agreed, if his Company were to be paid its share first. Under this agreement, in which petitioner joined, he continued to be entitled to a share in the remaining installments due under the lump-sum payment provision of the playwright's first contract with Warner Bros., while his rights in the percentage payments were released and he became expressly entitled to additional fixed cash payments, the receipt of which by him during the year in controversy gives rise to this dispute.

See Commissioner v. Hopkinson (CCA-2), 126 Fed(2d) 406.

Cf. Joseph A. Fields, 14 T.C. 1202.

While it may be true that petitioner previously had no direct contract with Warner Bros., it seems evident from the conduct of the parties that his interest in the entire transaction was sufficiently immediate and direct so that Warner Bros. insisted upon a release by him and was prepared to and did pay substantially for the abandonment of his rights. The result was that there was in effect merely a novation by which the indeterminate payments to which petitioner had previously been entitled were converted into a single lump sum which he received in the year in issue. See Escher v. Commissioner (CCA-3), 78 Fed.(2d) 815; George K. Gann, 41 B.T.A. 388; Thurlow E. McFall, 34 B.T.A. 108; Shuster v. Helvering, supra. ‘The 'purchase’ of that future income did not turn it into capital, any more than the discount of a note received in consideration of personal services. The commuted payment merely replaced the future income with cash.‘ Helvering v. Smith (CCA-2), 90 Fed.(2d) 590, 592.

A release or extinguishment of an obligation is not ordinarily treated as a sale or exchange under section 117. Fairbanks v. United States, 306 U.S. 436; Hale v. Helvering (CA-DC), 85 Fed.(2d) 819.

No violation of the legislative design can result from this treatment. The special lenience with respect to capital gains has its genesis in the possibility that since increases in the value of capital assets may cover a number of years, taxation of the total gain in any one year is inequitable. See House Report No.350, Ways and Means Committee, 67th Cong., 1st Sess., 10. A similar approach now exists to the compensation for personal services rendered over a term of years. Section 107, Internal Revenue Code. If petitioner's situation fails to entitle him to that gentler treatment, it does not call for distortion into something which it is not, but merely confirms the conclusion that it was not a statutory purpose to grant special privileges under such circumstances as these.

As to the second issue, our finding of fact that petitioner actually expended the claimed amounts in futherance of his business as a producer is dispositive. In this respect the deficiency must be disapproved.

Decision will be entered under Rule 50.