JOSE v. COMMISSIONER

Respondent determined a deficiency in petitioner's income tax for 1953 of $106,802.78. The issues are: (1) Whether the amount of $151,938.74 received in 1953 by petitioner constituted a long-term capital gain from the sale or exchange of a capital asset within section 117, I.R.C. 1939, or compensation for services rendered and taxable as ordinary income; (2) whether an accrual by petitioner, on a cash method of accounting, of 1953 foreign taxes, in addition to amounts paid in 1953 for prior years' foreign taxes, was properly taken as a credit against 1953 taxes within section 131, I.R.C. 1939.

FINDINGS OF FACT.

The stipulated facts are found.

During 1953 petitioner was a resident of the State of New York. He filed his return for calendar year 1953 with the district director of internal revenue, Upper Manhattan, New York, on a cash method of accounting.

Issue 1. Capital Gains.

Since 1935, petitioner has been an actor. From 1935 until May 7, 1952, he devoted the major portion of his efforts to the legitimate stage, where he appeared as an actor, director, and producer.

The first motion picture in which petitioner appeared was "Joan of Arc." Petitioner's salary for appearing in this picture was $50,000. It was made in the summer and fall of 1947. From that time until May 7, 1952, petitioner appeared in four pictures and received salaries as follows:

                                                                      Salary
    Time picture made                   Name of picture              received

Spring 1949 ---------------   Whirlpool --------------------------   $50,000
Fall 1949 -----------------   Crisis -----------------------------    75,000
1950 ----------------------   Cyrano de Bergerac -----------------    30,000
Summer 1951 ---------------   Anything Can Happen ----------------    75,000

Prior to November 1, 1951, a man named LaMure wrote the novel "Moulin Rouge" and the play "Monsieur Toulouse," hereinafter called the novel and play, respectively. The play was based on the novel.

On November 1, 1951, petitioner (as "Manager") and LaMure (as "Author") entered into a dramatic production contract, hereinafter called the 1951 contract, whereby LaMure leased to petitioner the sole and exclusive right to produce and present his play on the "speaking stage" in the United States and Canada on or before June 1, 1952, and petitioner agreed to pay LaMure, as royalties, certain percentages of the gross weekly box office receipts. Upon the signing of the contract petitioner agreed to pay LaMure $500 as an initial advance against royalties. The contract stated in part:

SEVENTH: Motion Picture and Additional Rights.

(The primary business function and occupation of regular theatrical managers is the stage production of plays. Rights in the play, other than stage presentation rights, are referred to as subsidiary rights. These include the motion picture rights, radio, amateur, music publication and other rights enumerated in Article VI hereof [the Supplemental Provisions]. These rights are exploited by motion picture producers, radio broadcasters, amateur companies, publishers, etc. All of them must be the subject of bargaining negotiations to secure adequate remuneration for the Author's work. The stage production is essential alike to the realization of the play and to an evaluation of its drawing power. A successful run also publicizes the play and adds materially to the value of the subsidiary rights. The Manager customarily participates in the proceeds of some such rights if they are disposed of within specified periods after production.)

In the event that under the terms hereof [petitioner] shall be entitled to share in the proceeds of the Motion Picture and Additional Rights hereafter referred to, it is agreed that [petitioner] shall receive * * * [40 per cent of the rights in the following: Motion picture; radio and television; second-class touring; stock performances; amateur performances; musical comedy, operetta and grand opera based upon the play; foreign language performances in the United States; condensed and tabloid versions; and commercial]. After ten (10) years [petitioner's] share of the proceeds from the foregoing rights shall be reduced as provided for in * * * [the Supplemental Provisions].

* * * * * * *

TENTH: Additional Clauses.

* * * * * * *

D. In addition to the rights of assignment provided in the Supplemental Provisions, [petitioner] shall have the right to assign this contract to a partnership in which [he] is the general partner or one of the general partners.

* * * * * * *

F. [Petitioner] shall pay a further advance of Five Hundred Dollars ($500) by December 1, 1951 and a further advance of Five Hundred Dollars ($500) by January 1, 1952.

G. [Petitioner] shall have the right to extend the production date to December 1, 1952 by paying an additional advance of Fifteen Hundred Dollars ($1500) by the production date hereinbefore specified.

* * * * * * *

J. All dramatic, motion picture, radio and television rights in the novel MOULIN ROUGE shall merge in and with the play during the existence of this contract. If [petitioner] produces and presents the play for a period sufficient to entitle him to a share of the proceeds of the sale or lease of said rights in the play, then said rights in the novel shall merge in and with the play throughout the copyright period of the play.

K. The Author represents that he owns and hereby warrants the sole and exclusive dramatic rights in and to his novel "Moulin Rouge" and his play "Monsieur Toulouse" based upon the said novel, story, literary composition of the said novel and play, free and clear of all liens, claims, encumberances [sic], and infringements [against the rights of others] and that no rights therein have been or will be granted to others * * * [during the existence of this agreement]; * * *

* * * * * * *

[Stapled to the page for Clauses F through K of "TENTH: Additional Clauses" appears the following paragraph:]

The Author and [petitioner] contemplate that, if the parties can mutually agree, they may enter into an agreement by which [petitioner] acquires the motion picture rights of the novel and play for the purpose of producing or substantially participating in the production of a motion picture based upon the novel and play. If [petitioner] desires, the Author and Nat Goldstone Agency and [petitioner] shall, not later than three (3) weeks after the New York opening of the play, discuss a proposed deal for [petitioner] to acquire said rights. It is understood and agreed, however, that the Author shall be under no obligation to grant the rights to [petitioner] unless the Author is satisfied with all the terms and conditions.

* * * * * * *

SUPPLEMENTAL PROVISIONS.

* * * * * * *

ARTICLE XII.

Assignment and Bankruptcy.

Section 1. Assignability of Rights.

All rights granted by this Agreement are personal, and neither this Agreement nor the rights granted hereby to [petitioner] shall be assigned by [petitioner], nor shall the play be sublet by [petitioner], without his first having obtained the consent in writing of the Author; except that an assignment may be made to a corporation or company in which [petitioner] has the controlling interest or of which he is the directing head, and in that event [petitioner] shall remain personally liable for the fulfillment of the terms and conditions of this Agreement in the same manner as though no such assignment had been made. Where rights are granted to a corporation, association or partnership, such rights shall not be assigned without the consent in writing of the Author. Any assignee of [petitioner's] rights under this Agreement must in writing assume the obligations of [petitioner] under this Agreement.

Some of the other supplemental provisions of the 1951 contract are: (1) All rights granted to petitioner by the contract would cease and terminate if he failed to produce and present the play on the "speaking stage" within the specified time limit and under certain conditions, or if he failed to comply with other contractual provisions; (2) petitioner would receive a percentage of the proceeds from the disposal of "Motion Picture and Additional" rights referred to in clause "SEVENTH" if he produced and presented the play within the specified time limit, and under certain circumstances and conditions; (3) LaMure retained for his sole benefit —

complete title, both legal and equitable, in and to all rights whatsoever (including, but not by way of limitation, the Motion Picture Rights, Stock Rights, Amateur Rights, Radio and Television Rights, Musical Version, Foreign Language Performing Rights in the United States, Performing Rights in Condensed and Tabloid Versions), other than the rights specifically herein leased to [petitioner] * * *

and (4) the "Motion Picture and Additional" rights referred to in clause "SEVENTH" could not be disposed of or sold until the play was produced and presented on the stage before a paying audience, unless petitioner otherwise consented.

The 1951 contract was the only agreement entered into between petitioner and LaMure with respect to petitioner's acquisition of any rights or interests in or to the novel.

Pursuant to the 1951 contract petitioner paid LaMure the sum of $1,500. He did everything necessary to further the production of the play. This involved working with LaMure in the preparation of the play.

Subsequent to November 1, 1951, petitioner learned that certain parties contemplated the production of a motion picture based upon the novel. He instructed his attorney and agent that if they were approached on his acting services or his property rights in the novel, he wanted certain compensatory conditions in the contract. At about the same time, and on several occasions, petitioner and his attorney conversed with LaMure, who wanted to sell, unencumbered, the motion-picture rights to the novel. LaMure requested that petitioner release his rights in the novel or join in a contract for the sale of such rights. Petitioner told LaMure that he would abandon the stage production for the motion-picture production, provided that, if the picture succeeded, he would be compensated for such abandonment.

Moulin Productions, Inc., hereinafter called Moulin, was one of the parties negotiating for the motion-picture rights to the novel. Moulin's attorney wanted clear unencumbered motion-picture rights, which were all Moulin was interested in. He required either an annulment or conveyance of the 1951 contract between petitioner and LaMure. He thought that contract imposed an encumbrance on the motion-picture rights to the novel.

In a meeting in December 1951 or January 1952, at which were present petitioner's attorney, LaMure's agent, and an agent for John Huston Productions, Inc., hereinafter called Huston, Moulin's attorney reviewed the "deal" as he then understood it, which involved percentages of profits to LaMure, Huston, and Ferrer. It was suggested that of the total percentages being paid to all of the parties a percentage be allocated to Ferrer and to LaMure for the motion-picture rights. Various percentages were divided and allocated, with Huston receiving a percentage, LaMure receiving a percentage, and Ferrer receiving a percentage. It was stated that the percentage payment to petitioner was to be his compensation for his interest in the 1951 contract.

Under date of February 7, 1952, LaMure wrote the following letter to petitioner:

1. I hereby warrant, represent and agree that

(a) The contract dated November 26, 1951, entered into by me with John Huston Productions, Inc., * * * for the production of a motion picture based upon my novel "MOULIN ROUGE", is valid and subsisting and is now in full force and effect. * * *

* * * * * * *

2. I agree to comply fully with all of the terms and provisions of said agreement * * * and to execute all necessary documents consonant with said agreement to facilitate the production of said motion picture starring you in the role of Toulouse-Lautrec * * *.

3. For the purpose of inducing me to enter into this agreement and for other good and valuable consideration, it is agreed that that certain dramatic production contract dated November 1, 1951 between you and me relating to "MOULIN ROUGE" is hereby cancelled and terminated in all respects whatever and each of us is hereby released and discharged from and of any and all obligations and agreements thereunder and, without limiting the generality of the foregoing, it is agreed that all rights acquired by you in the novel "MOULIN ROUGE" and the play based upon said novel, including but not limited to the legitimate stage dramatic rights under and pursuant to said agreement dated November 1, 1951 and any and all other agreements between us pertaining to said subject matter are hereby reassigned to me and shall be deemed to have automatically reverted to me, without the necessity of the execution of any further documents or instruments. * * *

If the foregoing correctly sets forth our full and complete understanding with reference to the foregoing subject matter, kindly signify your acceptance and agreement thereto by affixing your signature at the place provided below.

Under date of March 11, 1952, petitioner's attorney wrote petitioner's agent as follows:

David Stillman [president and counsel of Moulin] called me yesterday. He wanted to have a release of the dramatic rights. I explained to him that you had it, with instructions to deliver it to LaMure upon the closing of the contract. He said the contract was all set for closing. When I inquired why it hadn't been closed, he said that you wanted some further changes in the contract.

Sometime after February 7, 1952, petitioner signed LaMure's February 7, 1952, letter. His agent or attorney was instructed not to deliver this letter to LaMure until petitioner signed a contract with Moulin. The signed letter was not delivered to or received by LaMure prior to May 14, 1952. This was one of the documents whereby Moulin acquired motion-picture rights to the novel.

Petitioner did not produce or present on the stage the play "Monsieur Toulouse."

On May 7, 1952, petitioner and Moulin entered into a contract, hereinafter called the Moulin contract, which stated in part:

ROMULUS FILMS LIMITED * * * proposes to produce in England and on the continent of Europe a motion picture tentatively entitled "MOULIN ROUGE" * * * to be based upon a novel of the same name by Pierre La Mure; and

* * * MOULIN, in consideration of the providing of certain financing and facilities in connection with the production of the Picture will be vested with the Western Hemisphere distribution rights in and to the Picture; and

* * * MOULIN is desirous of engaging the services of [petitioner] to render his services in the production of the Picture for and on behalf of ROMULUS [Films],

Pursuant to the Moulin contract petitioner agreed to render his exclusive services as an actor by portraying the role of Toulouse-Lautrec in the motion picture "Moulin Rouge" and, in paragraph 4, Moulin agreed to pay full compensation for petitioner's services, as follows: 4(a)—$50,000 during the first 12 weeks of services rendered; 4(b)—a weekly rate of $10,416 for services rendered after the first 12 weeks; 4(c)—$50,000 deferred payment out of Moulin's net receipts remaining after recoupment of certain costs; 4(d)—17 per cent of 65 per cent of net profits (as defined) from the distribution of the picture in the Western Hemisphere until petitioner received $25,000 and thereafter 12¾ per cent of net profits; 4(e)—3¾ per cent of net profits (as defined) from the distribution of the picture in the Eastern Hemisphere. Paragraph 4(d) was referred to in the contract as the "percentage compensation."

Some of the other provisions of the Moulin contract are: (1) The services to be rendered by petitioner were unique and, upon his breach, Moulin's remedy in an action at law would be inadequate; (2) subject only to its obligations to pay petitioner compensation, Moulin was not required to utilize petitioner's services or scenes in which petitioner appeared; (3) Moulin could terminate petitioner's employment and be released generally from any further obligations except to pay petitioner compensation due and unpaid at the rate prescribed in paragraph 4(a) if (a) petitioner was unable to perform due to a physical or mental infirmity, or (b) an unavoidable accident interrupted production of the picture, or (c) petitioner failed to perform required services to the best of his ability; if an (a) or (b) contingency occurred, and certain circumstances existed, petitioner would receive compensation referred to in paragraph 4(c), (d), and (e) of the contract prorated for the period he rendered services to Moulin; (4) Moulin could terminate the contract and be released from all obligations if petitioner's conduct was without regard to "public conventions and morals," unless certain circumstances existed whereby petitioner would receive compensation referred to in paragraph 4(a), (c), (d), and (e) of the contract prorated for the period he rendered services to Moulin; (5) Moulin had the right to terminate and cancel the contract if Moulin attempted to purchase insurance on petitioner and an insurance company subsequently rejected petitioner; (6) petitioner had the right to compensation referred to in paragraph 4(d) of the contract in any "remake" or sequel to the picture in which Moulin owned an interest.

Paragraph 33 of the Moulin contract stated:

This agreement shall be construed and interpreted in accordance with the laws of the State of New York, and shall not be amended or modified except by an agreement in writing, signed by the party to be charged with such amendment or modification.

The right to share in "remake" or sequel income is given normally only to authors, producing companies, or those who have a proprietary interest in basic literary property.

By agreement and assignment dated May 12, 1952, LaMure sold to Huston all motion-picture rights to his novel. Paragraph 19 of this agreement stated:

That certain agreement between the parties hereto dated the 26th day of November, 1951 is hereby superseded in all respects.

By assignment dated May 12, 1952, Huston transferred to Moulin "all of * * * [its] right, title and interest * * * in, to, and under the agreement dated May 12th, 1952, between * * * [LaMure and Huston]." On the same date Moulin assumed and agreed to perform the terms, covenants, and conditions contained in the agreement between LaMure and Huston.

Moulin acquired the entire motion-picture rights to the novel by means of Huston's assignment of the Huston-LaMure agreement and petitioner's signature to the letter from LaMure dated February 7, 1952.

Under date of March 3, 1953, David B. Stillman, president and counsel of Moulin, wrote petitioner as follows:

This will confirm that in my negotiations on behalf of Moulin * * * with your attorney * * * for the sale of the dramatic rights held by you to the property entitled "MONSIEUR TOULOUSE" and the novel "MOULIN ROUGE", it was understood that the consideration for such sale price was the payments due, or to become due, to you under Clause 4(d) and Clause 4(e) of the agreement dated May 7, 1952, between you and Moulin * * *

Pursuant to paragraph 4 of the Moulin contract, petitioner received from Moulin during 1953 the total sum of $287,779.20, of which the respective amounts of $57,555.84 and $54 were withheld for Federal income taxes and social security contributions. Moulin's cash disbursements book charged the account "Moulin Rouge" and recorded these payments as follows (in even dollars):

--------------------------------------------------------------------------------
           Date             |  Gross   | Withholding |    Social    | Net amount
                            |  amount  |     tax     | security tax |
----------------------------|----------|-------------|--------------|-----------
Aug. 3 -------------------- | $109,027 |     $21,805 |          $54 |    $87,168
Aug. 12 ------------------- |   44,848 |       8,969 |          154 |     35,824
Oct. 6 -------------------- |   92,802 |      18,560 | ------------ |     74,241
Nov. 12 ------------------- |   24,804 |       4,960 | ------------ |     19,843
Dec. 8 -------------------- |   16,296 |       3,259 | ------------ |     13,036
--------------------------------------------------------------------------------

1 This amount was refunded to petitioner on Aug. 26, 1953.

Moulin's cash disbursements book for 1952 and 1953 reflected the following: (1) Disbursements on August 12, October 6, November 12, and December 8 of 1953, totaling $178,751.46 and labeled as "Participating Interests" to petitioner, represented payments pursuant to paragraph 4(d) of the Moulin contract; and (2) the August 3, 1953, disbursement of $109,027.74 represented a salary payment to petitioner.

Petitioner's return for 1953 reported the amount of $109,027.74 as salary income from Moulin. The return reported on Schedule D, as a long-term capital gain, the amount of $151,938.74 ($178,751.46 less expenses of $26,812.72) as a sale or exchange of the "Dramatic & Motion Picture Rights to `Moulin Rouge'." In his deficiency notice respondent determined that "$151,938.74 * * * constitutes ordinary income under the provisions of Section 22 * * *."

Except for the play "Monsieur Toulouse," petitioner never at any material time acquired motion-picture rights in any of the plays he had previously produced. Prior to May 7, 1952, he never acquired any literary property for purposes of selling it to a motion-picture studio.

Petitioner was not a dealer in literary property. He did not hold such property primarily for sale to customers in the ordinary course of his trade or business.

The August 3, 1953, disbursement of $109,027.74 represented a payment for petitioner's appearance in the picture "Moulin Rouge."

The November 1, 1951, contract between petitioner and LaMure created a capital asset in the hands of petitioner. The consideration received by petitioner on or after May 7, 1952, pursuant to paragraph 4(d) of the Moulin contract, constituted the proceeds of the sale or exchange of a capital asset held for a period exceeding 6 months.

Issue 2. Credit for Taxes.

During 1953 petitioner paid $2,343.19 to the Bureau of Income Tax, San Juan, Puerto Rico. This amount represented income taxes owed by petitioner for 1946 and 1952. During 1954 petitioner filed an "Individual Income Tax Return" with the Bureau of Income Tax, San Juan, Puerto Rico, showing an income tax liability of $3,013.41 for 1953. Petitioner did not pay this liability during 1953.

Petitioner's return for 1953 reported on Form 1116, Statement in Support of Credit Claimed by Individual for Taxes Paid or Accrued to a Foreign Country or a Possession of the United States, a claim for credit for taxes "Pd. & Accrued." Petitioner wrote these words in a space which the form footnoted as follows:

If income return is based on income "accrued," or you elect under Section 131 (d) to claim credit for taxes accrued, write "accrued" in the space provided. * * *

On page 3, line 10, of the return he entered the amount of $5,356.60 as "income tax payments to a foreign country or U.S. possession." Respondent disallowed as a credit the amount of $3,013.41.

An amount of $5,356.60 constituted a credit for foreign taxes in 1953.

OPINION.

OPPER, Judge:

Issue 1.

Without putting too fine a point upon it, it is clear that petitioner had acquired a beneficial interest of some nature in the book and play which later became "Moulin Rouge."

Defendant * * * [the author] stresses the fact that all right, title and interest in the copyright were reserved to defendants by agreement. However, it is the law that, though the title in the copyright of a play may be reserved to one of the parties, the exclusive licensee to present the play has an equitable interest therein. * * * [citations omitted]. Defendants here were trustees of the copyright for the benefit of both themselves and plaintiff [who was given the exclusive right to present the play], and defendants may not, in justice, retain all the proceeds received by them as compensation for an unauthorized appropriation of the play which is owned in part by plaintiff. * * * Where * * * plaintiff by express agreement was to have not only an exclusive grant to produce the play but also a 50% interest in all sums derived from motion picture rights, there can be little doubt as to the justice of his claim to a share in defendants' recovery for the unauthorized production of the motion picture of the play * * *. [McClintic v. Sheldon, 55 N.Y.S.2d 879, 882 (1945) affirmed per curiam 295 N.Y. 682, 65 N.E.2d 328 (1946).]

These rights were of sufficient significance to cause the ultimate producer's insistence on their acquisition by means of a "release" from petitioner before proceeding with production.1 "The use of the word `cancellation' is not determinative where something is transferred," as it was here. Isadore Golonsky, 16 T.C. 1450, 1451, affd. (C.A. 3) 200 F.2d 72, certiorari denied 345 U.S. 939; cf. Nat Holt, 35 T.C. 588.

The remaining problems are what was the consideration and when was it paid. There is no specific provision in the final contract dividing the payments between those for petitioner's personal services and those for his property rights. This ambiguity was, however, resolved by the introduction at the trial, over respondent's vigorous objection, of oral and written evidence outside the contract itself.

Without resorting to the principle that such statements are admissible despite the parol evidence rule in litigation involving other parties, Stern v. Commissioner, (C.A. 2) 137 F.2d 43, affirming a Memorandum Opinion of this Court; cf. Commissioner v. Dwight's Estate, (C.A. 2) 205 F.2d 298, certiorari denied 346 U.S. 871, reversing 17 T.C. 1317, we can hence consider this evidence under the conceded principle that proof of preliminary negotiations is admissible in any event where the writing itself is silent or ambiguous. Rasmussen v. New York Life Ins. Co., 267 N.Y. 129, 195 N.E. 821 (1935); District of Columbia v. Northeastern Const. Co., (C.A.D.C.) 70 F.2d 779.

Not only were the payments for these capital assets as so defined in paragraph 4 (d) of the final contract made more than 6 months after petitioner's acquisition of his interest, but the contract under which they became due from the ultimate assignee was not entered into until after the period required by the capital gains section.2 And respondent inferentially concedes that petitioner was not in the business of dealing in literary properties and that his interest in the book and play was consequently not held for sale to customers in the ordinary course of business. See Pat O'Brien, 25 T.C. 376, 386. Nor was it to any extent the consequence of, or consideration for, petitioner's personal services.3 Cf. Herman Shumlin, 16 T.C. 407; Irving Berlin, 42 B.T.A. 668; Nat Holt, supra. See Jack Benny, 25 T.C. 197; Julius H. (Groucho) Marx, 29 T.C. 88.

It seems to us to follow that petitioner correctly reported the gains in dispute and that the deficiency must to that extent be disapproved. Nat Holt, supra.

Issue 2.

All of the facts were stipulated and present a question of first impression under section 131, I.R.C. 1939.4 Petitioner contends that he is entitled to a foreign tax credit for prior years' taxes paid and also for taxes accrued within the year in dispute. Respondent, on the other hand, claims that petitioner's credit is limited to taxes either paid or accrued, but not both, and that petitioner failed to elect the accrual method for purposes of section 131 (d).

There can be no question that this section by its use of the phrase "irrespective of the method of accounting employed" is intended to be an exception to the general rule of section 41. Whether or not an accrual basis taxpayer would be permitted to credit cash tax payments in the absence of the stipulated election, we need not now decide. Cf. Carter, Rice & Co., 28 B.T.A. 687. The only question here is whether petitioner, having attempted to exercise the accrual election though on a cash basis, may in the same year deduct cash payments for prior years' taxes.

The provision in question has been in effect for many years. Its purpose was to permit as a credit against United States taxes, payable for a given year, the foreign taxes applicable to the same year, even though not yet paid, or possibly even due.5 To prevent distortions of tax liability at the taxpayer's option, and double credit of the same taxes, the condition was added that the election once made would continue for future years.

We see nothing in the language or purpose of the legislation inconsistent with what petitioner is here attempting. The statute clearly contemplates that exercise of the election will work some sort of change. Whenever there is a change in accounting methods, certain items will tend to double up or stretch out. Nothing strange or surprising has occurred here in this respect. "The fact that changes in accounting methods sometimes result in the bunching of income in the year of change is neither unique nor unusual." Southeast Equipment Corporation, 33 T.C. 702, 705, on appeal (C.A. 6). See also C. L. Carver, 10 T.C. 171, affirmed per curiam (C.A. 6) 173 F.2d 29.

Respondent's position would have the effect of eliminating any true election except in the first year in which any return is filed. In any subsequent year, if respondent is sustained, a taxpayer may exercise the election only under pain of giving up the credit for prior taxes which may not have been actually paid. Such a construction is neither necessary nor in accord with the legislative purpose.

In this respect also, we regard the deficiencies as erroneous.

To take account of conceded items,

Decision will be entered under Rule 50.