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American Technology Resources v. U.S.

filed: January 17, 1990.

AMERICAN TECHNOLOGY RESOURCES, APPELLANT,
v.
UNITED STATES OF AMERICA; JAMES A. PITTS, APPELLANT, V. UNITED STATES OF AMERICA; ALBERT S. PITTS, APPELLANT, V. UNITED STATES OF AMERICA; THOMAS M. PITTS, APPELLANT, V. UNITED STATES OF AMERICA



On appeal from the United States District Court for the Eastern District of Pennsylvania, D.C. Civil Action Nos. 86-5769, 86-5770, 86-5773, 86-5774.

Hutchinson, Nygaard, and Weis, Circuit Judge.

Author: Nygaard

Opinion OF THE COURT

NYGAARD, Circuit Judge.

This is an appeal from a judgment in favor of the United States. The district court adjudicated appellants liable under 26 U.S.C. § 6700, the penalty provision for promoting abusive tax shelters for selling grossly overvalued distributorship franchises. Appellants raise two issues: first, whether the district court erred in concluding that the value of the American Technology Resources, ("ATR"), distributorships was "directly related" to the amount of any deduction allowable under the Internal Revenue Code; and, second, whether the district court abused its discretion in qualifying the government's expert and consequently erred by denying appellants' motion for directed verdict on the ground that the United States presented no evidence of the ATR distributorships' value.*fn1 We conclude that the value of the ATR distributorship is directly related to the amount of a franchise deduction allowable under 26 U.S.C. § 1253(d) and that the district court did not abuse its discretion in qualifying Professor Jeffrey Jaffe as an expert in business valuation. We will affirm.

I

Appellant ATR, a Nevada corporation with its principal place of business in Media, Pennsylvania, produces and sells videodisc equipment. Appellants Albert Pitts, James Pitts and Thomas Pitts (The Pitts) own 77.5 percent of the issued and outstanding shares of ATR. All three are very active in ATR's operation. In 1982, Albert Pitts became president of ATR.

In November, 1982, ATR entered into an agreement with United States Motion Picture Institute (USMPI), whose president is Rolph Fuhrman, former president of ATR, permitting USMPI to sell ATR territorial distributorships in the tri-state Philadelphia area. The buyers of the distributorships would have an exclusive right to sell ATR's products for forty-three years. ATR and USMPI developed a promotional package for the ATR distributorships and the Pitts sold the distributorships. In all, thirty-four distributorships were sold.

The sale of each distributorship was described in the promotional package and structured as follows:

The cost of the distributorship was the product of the term of the distributorship in years multiplied by a factor equal to ten cents per resident of the territory. This amount was called the Contingent Principal Sum. The purchaser could elect to pay the Contingent Principal Sum in a series of twenty-three installments called the Incurred Annual Contingent Amount. The first three installments of the Incurred Annual Contingent Amount would each equal twenty percent of the Contingent Principal Sum and would be due in years one, two and three, respectively. No Incurred Annual Contingent Amount would be due in years four through ten. After year ten, an installment equal to two percent of the Contingent Principal Sum would be due each year for twenty years. The Incurred Annual Contingent Amount also would be reduced each year by an amount determined by a formula based on product cost and sales.

If preferred, the purchaser could defer payment to USMPI of the Incurred Annual Contingent Amount by electing to be 100 percent personally liable for the debt ("at risk"). Under this option, payment would not be due until twenty years after the debt was incurred. The obvious effect of the election is to create a deduction for franchise costs pursuant to 26 U.S.C. § 1253(d) with no corresponding cash outlay. Under this election the only cash outlay by the purchasers initially would be payment of three Guaranteed Performance Deposits, each equaling five percent of the Contingent Principal Sum. These payments would not be credited towards the Contingent Principal Sum.

ATR's promotional package focused heavily on the tax advantages of purchasing a distributorship. ATR emphasized that the purchaser "should receive a tax write-off equivalent to the portion of the Incurred Annual Contingent Amount for which he specifically elects to be personally 'at risk.' This can be as much as four times the amount of the Guaranteed Performance Deposit." App. at 109. ATR also assured the buyer that if any deductions were denied, ATR would provide legal services "at no additional cost." Id.

Thirty-two individuals and two limited partnerships purchased ATR distributorships. In 1982 and 1983, USMPI did not receive any money from these purchasers towards the Contingent Principal Sum; all elected to be "at risk" for their Incurred Annual Contingent Amount. The "at risk" amount for those two years was $7,130,000. In 1984 through 1986, USMPI received a minimal amount towards the Contingent Principal Sum which was generated from the profits of sales. In 1984 and 1985, the "at risk" amount was $5,575,000.

In 1986, the IRS assessed penalties against the appellants by authority of 26 U.S.C. § 6700 for promoting an abusive tax shelter for tax years 1982 and 1983. Pursuant to 26 U.S.C. § 6703(c), appellants paid fifteen percent of the penalties and filed an action in the United States District Court for the Eastern District of Pennsylvania contesting their liability. The case was tried before the court which made its findings of fact and conclusions of law, adjudicating appellants ...


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