MEMORANDUM OPINION
BEGHE, Judge.
This case is before the Court fully stipulated under Rule 122.
Respondent determined the following deficiencies, additions, and penalties with respect to petitioner's Federal income taxes:
Accuracy-Related
TYE Addition to Tax Penalty
July 31 Deficiency Sec. 6651(a)(1) Sec. 6662(a)
1995 $3,872,347 $ 960,069.25 $ 774,469.40
1996 5,405,717 1,072,572.62 1,081,143.40
After giving effect to various concessions,
1. Whether petitioner and Crocus International (Crocus) were engaged in a joint venture or joint ventures to conduct trade shows in the former Soviet Union (collectively, the foreign trade shows) during the last 7 months of the fiscal year ended July 31, 1995 and during the fiscal year ended July 31, 1996. Our holding that petitioner and Crocus were not engaged in any joint venture forecloses the question of how joint venture profits should be allocated between them.
2. In the alternative, whether and in what amounts petitioner is entitled to business expense deductions for the last 7 months of the fiscal year ended July 31, 1995 and for the fiscal year ended July 31, 1996, for amounts paid or payable to Crocus as compensation for its services in operating the foreign trade shows in addition to deductions already allowed petitioner for payments in reimbursement of Crocus's direct expenses of operating such shows. We hold that petitioner is entitled to deduct as additional business expenses the amounts of exhibition fees paid to Crocus by exhibitors located in the former Soviet Union and retained by Crocus as compensation for its services in operating the foreign trade shows.
Factual Background
In October 1990, Comtek Expositions, Inc. (petitioner), was incorporated in Connecticut and commenced business. At all relevant times, petitioner has been a C corporation. At the time petitioner filed the petition in this case, its principal place of business was in Wilton, Connecticut. During the taxable periods at issue, petitioner used the accrual method of accounting.
During the taxable periods at issue, petitioner's stockholders and their respective ownership interests were as follows:
Ownership
Stockholder Percentage
Aras Agalarov (Agalarov) .............................. 33.33
Leonid Pollak (Pollak) .............................. 26.67
Michael Tseytin (Tseytin) ............................. 26.67
Boris Kogan (Kogan) ................................... 13.33
The stockholders are parties to a stockholders' agreement (the stockholders' agreement), which recites that petitioner has issued and outstanding 200 shares of corporate stock held by the four stockholders in amounts consistent with the stipulated ownership percentages shown above. However, the stockholders' agreement contains some internal inconsistencies and discrepancies with stipulated facts. The first two lines of the stockholders' agreement recite that it is "dated as of this ____ day of _____, 1993"; the month and date in 1993 are left blank. The last two lines of the stockholders' agreement prior to the signatures recite "IN WITNESS WHEREOF, the parties have executed this Agreement on the date first above written." Attached to the stockholders' agreement is an "Exhibit B, Certificate of Stated Value" valuing the 200 shares of the corporation at $25,000 per share—a total of $5,000,000—that is "Dated: As of December, 31, 1992". Petitioner's Forms 1120, U.S. Corporation Income Tax Return, state that Agalarov
The stockholders' agreement not only contains restrictions on the transfer of shares, rights of first refusal, and purchase options and obligations of the type usually found in agreements among stockholders of closely held corporations; it also contains provisions effectuating the stockholders' and petitioner's expressed "desire to promote their mutual interest by agreeing that the business and affairs of the corporation shall be conducted subject to the terms and conditions hereof." Among the actions that can be taken only by unanimous vote of the Board of Directors are: "(i) obligating the Corporation to participate in any exhibition or exposition; * * * [and] (v) entering into any extraordinary agreement or incurring any extraordinary expense not in the usual and regular course of business * * *".
Article 10 of the stockholders' agreement, entitled "Agreement Regarding Revenues", provides "that the `net profits' (as defined herein)
From 1990 through July 31, 1996, petitioner conducted trade shows and exhibitions primarily in the former Soviet Union
From 1990 through July 31, 1996, Crocus's business activities included organizing, marketing, and presenting trade shows and exhibitions in the former Soviet Union. During this period, Crocus also engaged in other unrelated business activities.
During 1994, 1995, and 1996, Crocus maintained offices in Moscow; Crocus did not maintain an office or transact business in the United States. During 1994, 1995, and 1996, petitioner maintained no office in Russia.
Petitioner and Crocus leased exhibition space and facilities for trade shows from Expocentr, a Russian joint-stock company. Expocentr owned or controlled the Krasnaya Presnya exhibition complex in Moscow where many trade shows were held.
From 1990 through July 31, 1996, petitioner and Crocus had no written agreement governing their business or financial relationships. At all times relevant, neither petitioner nor Crocus controlled how the other conducted its business activities. At all times relevant, petitioner and Crocus were free to compete against each other in the trade show business. However, no foreign trade shows were organized by either petitioner or Crocus unless both petitioner and Crocus agreed to put on the trade show.
Most of the exhibitors at the foreign trade shows were U.S. companies, European subsidiaries of U.S. companies, and a few Asian companies. Some Russian companies also participated in the foreign trade shows. The foreign trade shows were usually organized by product line, such as computers and computer software, food, or clothing.
Before January 1, 1995, petitioner would secure commitments prior to the foreign trade shows from companies located in the United States and elsewhere to lease space from petitioner at the exhibition site to display their goods and services. Petitioner's employees attended other trade shows in the United States and Europe to solicit exhibitors for foreign trade shows; they also prepared sales brochures that were given to prospective exhibitors and advertised proposed trade shows in trade journals. Both the "Comtek" and "Crocus" names were used in the promotional materials and advertising.
Trade show exhibitors located outside the former Soviet Union paid their exhibition fees either by check payable to petitioner or by wire transfer to a bank account controlled by petitioner. Trade show exhibitors located in the former Soviet Union paid their exhibition fees to Crocus.
Trade show exhibitors located outside the former Soviet Union entered into contracts for exhibition space with petitioner. These contracts were signed by a representative of the exhibitor and a sales person employed by petitioner. The contracts provided that if the exhibitor were to cancel the contract, petitioner would retain all payments received as liquidated damages.
Generally, petitioner's employees handled all contacts with potential trade show exhibitors located outside the former Soviet Union. In some cases, a potential exhibitor from outside the former Soviet Union would instruct petitioner's employees to contact the exhibitor's business agent in Russia; in such a case, employees of Crocus would contact the business agent to see whether that company wished to participate in the foreign trade show. However, in those cases, petitioner still collected the exhibition fees.
Crocus supplied some or all of the following services to exhibitors at foreign trade shows: Security (general, overnight, and special); exhibit construction (including design assistance, furniture assembly, and exhibition assembly and mounting); exhibit maintenance and cleaning; exhibit demolition (including exhibit dismantling, transportation, and storage); trade show plumbing, electric, and telecommunications services (including installation and connection of exhibit lighting, telephones, and faxes); trade show exhibitor relations (including hotel and automobile assistance); trade show food and beverages services; trade show signs and flagging; local advertising and printing (including exhibitor manuals and show catalogues); relations with Expocentr; exhibition custom clearance; exhibition finance; and first night party for exhibitors in the Kremlin.
Petitioner's employees attended foreign trade shows and solicited exhibitors to participate in future trade shows. Petitioner's employees also provided liaison between exhibitors and Crocus's employees when exhibitors encountered problems.
Foreign trade show fees received by petitioner were first used to reimburse petitioner and Crocus for their direct expenses and any overhead allocable to foreign trade shows.
Post-December 31, 1994, Foreign Trade Shows
On January 1, 1995, petitioner, Crocus, and MBL International (MBL) entered into a reciprocal royalty agreement (the royalty agreement) with E.C.I. Management Services, Ltd. (ECI), a nonresident Irish corporation.
Like the stockholders' agreement, the royalty agreement contains internal inconsistencies and discrepancies with stipulated facts. First, Article 3.2 of the royalty agreement designates ECI as "payment agent" to receive all payments of fees for trade shows outside the United States, while all fees for trade shows in the United States are to be remitted to petitioner. The royalty agreement says nothing about fees to be collected by Crocus. After December 31, 1994, trade show exhibitors located outside the former Soviet Union either paid their exhibition fees by check in U.S. currency payable to petitioner or by wire transfer in U.S. currency to a bank account in the name of ECI, while exhibitors located in the former Soviet Union continued to pay their exhibition fees to Crocus. During the taxable periods at issue, i.e., January 1, 1995 through July 31, 1996, 90 percent of the fees for exhibition space at foreign trade shows were paid by exhibitors located outside the former Soviet Union, and the remaining 10 percent were paid by exhibitors located in the former Soviet Union.
Second, under Article 4.1 of the royalty agreement, ECI agrees to pay petitioner a royalty of 25 percent of gross revenues of foreign trade shows, while under Article 4.2 of the royalty agreement, petitioner agrees to pay ECI a royalty of 35 percent of gross revenues from trade shows in the United States conducted after March 1, 1995. Petitioner reported 25 percent of gross revenues from foreign trade shows in accordance with Article 4.1., except in cases where the foreign trade show was conducted solely by petitioner. Petitioner reported 100 percent of gross revenues from trade shows in the United States conducted after March 1, 1995, which contradicts Article 4.2 of the royalty agreement.
Third, the royalty agreement contains a debt offset provision pursuant to which ECI agrees to accept MBL's and Crocus's debt obligations to petitioner as payment of petitioner's debt obligation to ECI. The provision states that petitioner's obligation to ECI exceeds the amounts MBL and Crocus owe petitioner. However, Schedule A of the royalty agreement states that the total of MBL's and Crocus's debts to petitioner is exactly equal to petitioner's debt to ECI.
During 1995 and 1996, the stockholders of ECI were Fallon Nominees, Ltd. (Fallon), and Management Nominees, Ltd. (Management). Petitioner claims that none of its officers or stockholders owns shares of or otherwise controls ECI, Fallon, or Management or knows who owns or controls Fallon or Management. John Fitzgerald, a director of ECI, declared in an exhibit to the declaration of Frank Agostino (petitioner's counsel) in support of petitioner's motion for summary judgment, that petitioner had no direct or indirect control over ECI, and there was no identity or overlap of ownership between petitioner and ECI. However, under Article VI of the royalty agreement, petitioner has rights of first refusal over any of ECI's stock that ECI intends to assign, transfer, or dispose of.
After December 31, 1994, petitioner and Crocus continued to conduct trade shows and perform the underlying responsibilities related thereto in the same general manner they had before January 1, 1995. Specifically, Crocus continued to supply some or all of the same services to the exhibitors at foreign trade shows as it had supplied to exhibitors at such shows conducted before January 1, 1995.
On August 8, 1995, petitioner and Crocus signed contracts (the trade show contracts) with Expocentr to conduct three foreign trade shows at pavilions owned by Expocentr. The trade show contracts evidence contractual terms with respect to leasing pavilions owned by Expocentr. Although Crocus was a party to each trade show contract, under paragraph 9 of each of the trade show contracts, petitioner alone would be responsible for final settlement of accounts with Expocentr including remitting payments for rent, insurance, and advances to Expocentr. If there was any balance owed to or any amount due from Expocentr, petitioner alone was required to pay the balance or receive the credit. The trade show contracts do not refer to any joint venture between any of the parties.
On September 15, 1995, petitioner and Crocus signed a cooperation agreement with Expocentr (the cooperation agreement) that outlined their general understanding how future foreign trade shows would be conducted in Expocentr pavilions. The cooperation agreement does not refer to any joint venture between any of the parties.
The total gross revenue from exhibition fees for the foreign trade shows held during the last 7 months of the fiscal year ended July 31, 1995, was $13,071,216, and for the foreign trade shows held during the fiscal year ended July 31, 1996, was $20,687,586.
Factoring in adjustments to gross receipts agreed to by petitioner and respondent and disregarding receipts from trade shows conducted solely by petitioner and from shows conducted outside the former Soviet Union, foreign trade shows held from December 31, 1994 through July 31, 1995, produced the following net profit:
Gross exhibition revenues .......................... $13,071,216
Less: Crocus's direct expenses substantiated ....... 3,310,605
Less: Expocentr rent payments substantiated ....... 3,143,873
Less: Petitioner's direct expenses ................. 2,345,509
___________
Net Profit 4,271,229
Factoring in adjustments to gross receipts agreed to by petitioner and respondent and disregarding receipts from trade shows conducted solely by petitioner and from shows conducted outside the former Soviet Union, foreign trade shows held during the taxable year ended July 31, 1996, produced the following net profit:
Gross exhibition revenues ......................... $20,687,586
Less: Crocus's direct expenses substantiated ...... 4,003,930
Less: Expocentr lease payments substantiated ...... 7,003,947
Less: Petitioner's direct expenses ................ 3,563,363
___________
Net Profit 6,116,346
On its Federal income tax returns for the taxable years ended July 31, 1995 and July 31, 1996, petitioner reported as income 25 percent of gross receipts from foreign trade shows held after December 31, 1994, in accordance with the royalty agreement and deducted trade show expenses it incurred directly. Taking into account adjustments to gross receipts agreed to by petitioner and respondent and disregarding receipts from foreign trade shows conducted solely by petitioner and from trade shows conducted outside the former Soviet Union, petitioner reported net income of $922,295 from the stipulated $4,271,229 net profit for foreign trade shows held from December 31, 1994 through July 31, 1995 (25 percent of gross revenues, amounting to $3,267,804, minus petitioner's direct expenses of $2,345,509) and net income of $1,608,534 from the stipulated $6,116,346 net profit for foreign trade shows held during the fiscal year ended July 31, 1996 (25 percent of gross revenues, amounting to $5,171,897, minus petitioner's direct expenses of $3,563,363). In so doing, petitioner did not deduct any expenses incurred by Crocus, nor did petitioner deduct the lease payments for use of the Expocentr pavilion or any other pavilion located in the former Soviet Union.
Petitioner and Crocus did not file Forms 1065, U.S. Partnership Return of Income, for any taxable years ending on or before July 31, 1996. Crocus was not required to file and did not file U.S. corporation income tax returns for the 1994, 1995, and 1996 taxable years.
Procedural Background
On February 8, 2000, respondent issued a notice of deficiency to petitioner for the taxable years ended July 31, 1995 and July 31, 1996. Respondent's primary determination germane to the issues in this case was that petitioner's gross income for the 7-month period ended July 31, 1995 and for the fiscal year ended July 31, 1996, should be increased to include the 75 percent of gross receipts that had been paid to or received by ECI from petitioner and exhibitors in foreign trade shows in accordance with Articles 3.2 and 4.1 of the royalty agreement. The petition and answer were timely filed.
On January 2, 2001, respondent filed his first request for admissions and attached exhibits; on January 31, 2001, petitioner filed its first request for admissions. Responses to the respective first requests for admissions were filed by petitioner on February 2, 2001, and by respondent on February 26, 2001. Both parties admitted that the Internal Revenue Service (IRS) was pursuing a criminal investigation of petitioner's stockholders.
On February 2, 2001, respondent filed his application for a letter of request authorizing a foreign deposition under the United Kingdom
On February 8, 2001, petitioner filed its motion for summary judgment. Petitioner's position in the motion for summary judgement was that respondent could not ignore ECI's separate legal existence and include in petitioner's gross income amounts paid to ECI by petitioner and exhibitors in foreign trade shows in accordance with Articles 3.2 and 4.1 of the royalty agreement.
On November 20, 2001, the parties submitted the case to the Court fully stipulated under Rule 122 in a document entitled "First Stipulation of Facts" that included not only stipulations of fact and attached exhibits, but also stipulations of settled issues, the opposing contentions of the parties, and a set of ground rules to be observed by the Court in deciding the case as the parties have presented it.
In three separate paragraphs, the stipulation of facts document sets forth the opposing contentions and the ground rules as follows:
On January 16, 2002, the Court deemed moot petitioner's motion for summary judgment because the parties had stipulated that both ECI
Discussion
Petitioner has the burden of showing that the determinations in the notice of deficiency are erroneous. Rule 142(a); Welch v. Helvering [3 USTC ¶ 1164], 290 U.S. 111, 115 (1933).
Income is taxed to the person who earned it. Lucas v. Earl [2 USTC ¶ 496], 281 U.S. 111 (1930). The sole issue in dispute is how petitioner should report taxable income generated by foreign trade shows held after December 31, 1994. According to the stipulation of the parties and the terms of the royalty agreement, petitioner was supposed to receive 25 percent of gross receipts and pay its direct expenses out of these receipts, and ECI was supposed to receive the remaining 75 percent of gross receipts and make payments to Crocus and to Expocentr and other pavilion lessors in the former Soviet Union. Inasmuch as the parties have stipulated that the royalty agreement is to be disregarded for Federal income tax purposes, the question is whether petitioner is entitled to exclude or deduct from gross income of foreign trade shows conducted after December 31, 1994, any amounts in excess of Crocus's and petitioner's direct expenses and Expocentr rent payments, which, the parties have stipulated, petitioner is entitled to deduct in computing its taxable income for the periods at issue.
Petitioner contends Comtek and Crocus were in a joint venture or a series of joint ventures to conduct the foreign trade shows during the taxable periods at issue. Petitioner further contends that joint venture profits should be split between petitioner and Crocus in proportion to their respective direct expenses, or failing that, the net profits should be split equally.
If the Court should hold there was no joint venture and therefore include in petitioner's income all gross revenue from foreign trade shows, petitioner requests a deduction under section 162(a)(1)—in addition to its stipulated deductions for its direct expenses, Expocentr rent payments, and Crocus's reimbursed direct expenses—for amounts paid or payable to Crocus as a markup on Crocus's direct expenses as additional compensation for Crocus's services in operating the foreign trade shows. Petitioner argues that the Court should estimate the markup under the Cohan rule (Cohan v. Commissioner [2 USTC ¶ 489], 39 F.2d 540, 543-544 (2d Cir. 1930)) and requests that the markup equal at least 50 percent of net profits. Under either argument, petitioner requests the Court to allocate to each of petitioner and Crocus at least $2,135,614.50 (50 percent of $4,271,229 net profit) for the last 7 months of the fiscal year ended July 31, 1995, and at least $3,058,173 (50 percent of $6,116,346 net profit) for the fiscal year ended July 31, 1996.
Respondent argues that petitioner and Crocus did not conduct any joint venture during the taxable periods at issue. Respondent contends Crocus should not receive any markup as compensation for its services because Crocus was the alter ego of Agalarov. Instead, respondent urges us to disregard the corporate entities of petitioner and Crocus and view the transactions at the stockholder level, in accordance with Article 10 of the stockholders' agreement, under which petitioner's net profits of foreign trade shows conducted in the former Soviet Union are allocated 50 percent to Agalarov, with the other 50 percent split between Pollak, Tseytin, and Kogan.
We hold there was no joint venture between petitioner and Crocus in conduct of foreign trade shows during the taxable periods at issue. We interpret the parties' stipulation of facts to find that the foreign trade show fees paid to Crocus by exhibitors located in the former Soviet Union have been included in petitioner's stipulated gross income; we also find that Crocus retained such fees. We hold that petitioner is entitled under section 162(a)(1) to deduct such fees collected and retained by Crocus as compensation for the services of Crocus in operating the foreign trade shows.
Before setting forth the reasoning to support our holdings, we make some preliminary observations,
First, there is a significant omission from the stipulation of facts.
Second, in their briefs, petitioner and respondent each argue that net profits for foreign trade shows conducted after December 31, 1994, should be split in the same way net profits for pre-January 1, 1995, foreign trade shows were split. Paragraph 20 of the stipulation of facts states that petitioner contends that any net profits of pre-January 1, 1995, foreign trade shows were divided equally between petitioner and Crocus, whereas respondent contends that Crocus received nothing more than the reimbursement of its direct expenses and overhead. Respondent contends that petitioner received all net profits from pre-January 1, 1995, foreign trade shows, which were divided at the stockholder level of petitioner with Agalarov entitled to 50 percent of such net profits and the remaining 50 percent divided between Pollak, Tseytin, and Kogan. In addition, petitioner contends that it and Crocus orally agreed to an equal split of net profits from foreign trade shows conducted from 1990 to 1996.
Unlike the stipulations with respect to foreign trade shows conducted during the taxable periods at issue, the record does not provide enough information regarding the amount of net profits for the periods before January 1, 1995, to resolve the contentions of the parties. Petitioner and respondent did not present business and financial records for the periods before January 1, 1995, that state how petitioner reported fees collected by Crocus from exhibitors located in the former Soviet Union and the amount or percentage of fees collected by Crocus from such exhibitors. Also, the record does not disclose information regarding payments for leasing exhibition space in the former Soviet Union during these periods. Petitioner has provided no documentary or testimonial evidence that petitioner and Crocus had orally agreed to an equal split of net profits from pre-January 1, 1995, foreign trade shows.
Petitioner's and respondent's opposing contentions with respect to revenue or profit sharing between petitioner and Crocus or Agalarov for periods before January 1, 1995, are not agreed facts; instead they pose a hypothetical issue that might have a bearing on this case if we were prepared to make inferences about whether and how petitioner and Crocus would have agreed to alter their pre-January 1, 1995, business arrangements.
We do not resolve the disagreement between petitioner and respondent about whether and how petitioner and Crocus agreed to split net profits for pre-January 1, 1995, foreign trade shows. The record fails to provide evidence to resolve the respective contentions of petitioner and respondent, and resolution of this issue is not a prerequisite to our resolution of the case.
Third, agreeing in the stipulation of facts to disregard the royalty agreement and ECI for Federal income tax purposes, the parties have left the Court with an incomplete picture of the business and financial relationships of petitioner and Crocus during the taxable periods at issue. The problem has been aggravated by respondent's unexplained failure to follow through with discovery after the Court granted respondent's application for a letter of request authorizing a foreign deposition.
Against the background of the declaration in support of petitioner's motion for summary judgment "that dealing with quasi-government agencies in Russia is a sensitive mixture of politics, negotiation, and money," we follow the direction of paragraph 27 of the stipulation of facts to disregard any suspicions raised by the use of a tax haven jurisdiction as the locus for the royalty agreement to which petitioner became
We interpret the parties' stipulated instruction not to draw any adverse inference against either of them from the disregarded royalty agreement with ECI as a direction not to apply the rule of Wichita Terminal Elevator Co. v. Commissioner [Dec. 15,171], 6 T.C. 1158, 1165 (1946), affd. on other grounds [47-1 USTC ¶ 9253] 162 F.2d 513 (10th Cir. 1947) against either of them, despite the lack of relevant record evidence they did not show was not within their power to produce. We further interpret the parties' stipulated instruction not to draw adverse inferences as being primarily for the protection of petitioner and as directed primarily to what might be otherwise justified suspicions generated by the existence and terms of the royalty agreement in the first place, not by the stipulation of the parties to disregard the royalty agreement and ECI for the purposes of this case.
Issue 1. Whether Petitioner and Crocus Were Engaged in a Joint Venture or Joint Ventures To Conduct Foreign Trade Shows During January 1, 1995 to July 31, 1996
Whether there is a partnership for tax purposes is a matter of Federal, not local, law.
The required inquiry for determining the existence of a partnership for Federal income tax purposes is whether the parties "really and truly intended to join together for the purpose of carrying on business and sharing in the profits or losses or both." Commissioner v. Tower, supra at 287. Their intention is a matter of fact, "to be determined from testimony disclosed by their `agreement, considered as a whole, and by their conduct in execution of its provisions.'" Id. at 287 (quoting Drennen v. London Assurance Co., 113 U.S. 51, 56 (1885)).
In Commissioner v. Culbertson [49-1 USTC ¶ 9323], 337 U.S. 733, 742 (1949), the Supreme Court elaborated on this standard and stated that there is a partnership for Federal tax purposes when
In Luna v. Commissioner, supra at 1077-1078, this Court distilled the principles mentioned in Commissioner v. Tower, supra, and Commissioner v. Culbertson, supra, to set forth the following factors as relevant in evaluating whether parties intend to create a partnership for Federal income tax purposes (the Luna factors):
See also Estate of Kahn v. Commissioner, supra at 1189.
None of the Luna factors is conclusive of the existence of a partnership. Burde v. Commissioner [65-2 USTC ¶ 9733], 352 F.2d 995, 1002 (2d Cir. 1965), affg. [Dec. 27,064] 43 T.C. 252 (1964); McDougal v. Commissioner [Dec. 32,746], 62 T.C. 720, 725 (1974). We apply each Luna factor to the stipulated facts of this case to determine whether petitioner and Crocus engaged in a joint venture to conduct foreign trade shows during the taxable periods at issue.
1. The Agreement of the Parties and Their Conduct in Executing Its Terms
Petitioner admits there was no written agreement between petitioner and Crocus to operate foreign trade shows as a joint venture. However, petitioner argues that the trade show contracts and the cooperation agreement with Expocentr are written documents that evidence a joint venture.
The trade show contracts evidence contractual terms with respect to leasing pavilions owned by Expocentr. Under paragraph 9 of each of the trade show contracts, petitioner alone was obligated to pay rent and other fees for the use of the pavilions. The trade show contracts do not refer to any joint venture between any of the parties. Similarly, the cooperation agreement merely reflects a general understanding with Expocentr as to how future trade shows would be conducted in Expocentr pavilions; it says nothing about a joint venture between petitioner and Crocus.
Although the parties have agreed to disregard the royalty agreement for Federal income tax purposes, petitioner argues that the royalty agreement is a formal agreement to enter into a joint venture. However, the royalty agreement contains no provisions that refer to a business relationship between petitioner and Crocus or to any agreement that provides Crocus with a share of the profits. In form, the royalty agreement provides for a division of gross receipts between petitioner and ECI.
Petitioner argues that evidence of a joint venture agreement can be found in the stipulated fact that before January 1, 1995, no foreign trade shows were organized unless both petitioner and Crocus agreed to put on the trade show. However, this does not prove the existence of an agreement to join in a joint venture to share profits or losses or both as required by Commissioner v. Tower [46-1 USTC ¶ 9189], 327 U.S. 280 (1946). Rather, it reflects a continuation of the prior understanding or course of dealing between petitioner and Crocus to have their resources available at specific times and places to conduct foreign trade shows.
The existence or lack of a written agreement is not determinative of whether a joint venture existed between petitioner and Crocus. Sierra Club v. Commissioner [Dec. 50,080], 103 T.C. at 324; Cohen v. Commissioner [Dec. 17,845], 15 T.C. 261, 272 (1950) (The absence of an express agreement to share in losses is not material, since such an agreement may be implied from their agreement to share profits). In Beck Chem. Equip. Corp. v. Commissioner [Dec. 22,265], 27 T.C. 840 (1957), we found there was a joint venture on the basis of an oral agreement between the parties.
Even though petitioner claims there was an oral agreement between petitioner and Crocus to an equal split of net profits from foreign trade shows conducted from 1990 to 1996, petitioner has not introduced any documentary or testimonial evidence of the existence of any such alleged oral agreement. Petitioner has provided no evidence to show that it and Crocus did in fact split net profits equally.
This Luna factor weighs against the finding of a joint venture between petitioner and Crocus during the taxable periods at issue.
2. The Contributions, If Any, Which Each Party Has Made to the Venture
Petitioner and respondent agree that both petitioner and Crocus made significant contributions
3. The Parties' Control Over Income and Capital and the Right of Each To Make Withdrawals
Petitioner and Crocus did not have mutual or joint control over capital and income generated by foreign trade shows. During the taxable periods at issue, petitioner or ECI collected and controlled fees from exhibitors located outside the former Soviet Union, which accounted for 90 percent of all foreign trade show fees, and Crocus collected and controlled fees from exhibitors located in the former Soviet Union, which accounted for the remaining 10 percent of all foreign trade show fees. Nothing in the record indicates that Crocus had control over or a right to make withdrawals or to receive distributions or payments from the share of receipts collected by petitioner and ECI during the taxable periods at issue. Crocus is only a party to the royalty agreement between petitioner, Crocus, and ECI with respect to an offset of a debt. Nothing in the royalty agreement or the parties' stipulation indicates that Crocus was entitled to receive a share of net profits from the 75 percent of gross receipts to be paid to ECI.
Petitioner negotiated all contracts with exhibitors located outside the former Soviet Union, which accounted for 90 percent of fees collected for foreign trade shows. If an exhibitor were to cancel a contract with petitioner, petitioner would retain all payments received as liquidated damages.
This Luna factor weighs against the finding of a joint venture between petitioner and Crocus during the taxable periods at issue.
4. Whether Each Party Was a Principal and Coproprietor, Sharing a Mutual Proprietary Interest in the Net Profits and Having an Obligation to Share Losses, or Whether One Party Was the Agent or Employee of the Other, Receiving For His Services Contingent Compensation in the Form of a Percentage of Income
There is no evidence petitioner and Crocus had an agreement to share or did in fact share in the net profits or losses of foreign trade shows. We infer from the stipulated facts regarding the total gross revenues from foreign trade shows during the periods at issue and the 10 percent thereof received by Crocus from exhibitors located in the former Soviet Union that Crocus retained fees collected from such exhibitors as compensation for its services in operating the foreign trade shows.
The owner of a business may agree to compensate a hired manager or key employee with a percentage of the income of the business, or a broker may be retained to sell property for a commission based on the net or gross sales price. Even though both arrangements may culminate in a division of profits, neither constitutes a partnership unless the arrangement results in the parties' becoming coproprietors.
In Luna v. Commissioner [Dec. 26,967], 42 T.C. 1067 (1964), we held there was no partnership where the taxpayer was to receive a percentage of the renewal commissions from an insurance policy he had designed in exchange for his management services to the insurance company. In so holding, we focused on the following: That neither the taxpayer nor the insurance company in any way indicated, prior to the suit, an intent to join together as partners; partnership tax returns were not filed, and neither party held itself out to others as a joint venturer with the other party; the taxpayer was not authorized to engage in the insurance business except as an agent selling insurance policies; and the taxpayer and the insurance company would not and did not share in any losses resulting from the sale of the new type of policy.
Disregarding ECI and the royalty agreement, petitioner is the only party with a proprietary interest in the profit-producing activity of promoting and operating the foreign trade shows during the periods at issue. Crocus's retention of fees collected from exhibitors located in the former Soviet Union does not, by itself, result in a joint venture. It may fairly be inferred from the stipulated record that Crocus was reimbursed for its direct expenses only, not its overhead expenses. See supra pp. 25-26. Although Crocus was subject to the risk of loss of its unreimbursed overhead expenses, Crocus's risk of loss is trivial as compared with petitioner's risk of loss arising from its liability for the substantial Expocentr rent obligations in addition to its own direct expenses. The facts as a whole suggest Crocus was not a coproprietor because it did not share in possible losses of substantial Expocentr rent obligations or petitioner's direct expenses, did not negotiate the trade show contracts or cooperation agreement with Expocentr and contracts with exhibitors located outside the former Soviet Union, and did not own any rights to foreign trade show profits.
5. Whether Business Was Conducted in the Joint Names of the Parties
The evidence with respect to this Luna factor is mixed. One trade catalogue listed both petitioner and Crocus as the producers and managers of the trade show; another catalogue listed petitioner as the producer and manager of the trade show and listed Crocus as the marketer of the trade show in the former Soviet Union. Advertisements in English direct exhibitors to contact petitioner for information on exhibiting in future trade shows. The trade show catalogues contain letters from officers of both petitioner and Crocus thanking exhibitors for attending the trade shows. Overall, trade show catalogues do not conclusively suggest to third parties that business was conducted in the joint names of Comtek and Crocus.
Both petitioner and Crocus signed the trade show contracts and cooperation agreement with Expocentr. However, under the three trade show contracts in evidence, petitioner alone was obligated to pay rent and other fees for the use of the pavilions. Crocus is involved in none of the proposals for future cooperation between petitioner and Expocentr. These contracts suggest that petitioner was the principal party in negotiations with Expocentr.
This Luna factor is neutral with respect to whether petitioner and Crocus engaged in a joint venture during the taxable periods at issue.
6. Whether the Parties Filed Federal Partnership Returns or Otherwise Represented to Respondent or to Persons With Whom They Dealt That They Were Joint Venturers
Under section 6031 and section 1.6031-1(c) and (d), Income Tax Regs., every partnership engaged in trade or business, or having income from sources within the United States was required to file a partnership return. Petitioner and Crocus did not file partnership returns for the taxable periods at issue. It is not clear from the record whether petitioner and Crocus conducted foreign trade shows as a joint venture engaged in trade or business, or having income from sources, within the United States. The purpose of this Luna factor is to determine whether petitioner and Crocus represented to respondent that they conducted foreign trade shows as a joint venture. In deciding this issue, it is not necessary to determine whether petitioner and Crocus were required to file a partnership return under section 6031 and section 1.6031-1(c) and (d), Income Tax Regs.
Regardless of whether petitioner and Crocus were required to file a partnership return, neither petitioner nor Crocus represented to respondent that they conducted foreign trade shows during the taxable periods at issue as a joint venture. On its returns for the taxable periods at issue, petitioner did not explain or state that it was engaged in a partnership with any entity; petitioner merely reported its share of gross income from foreign trade shows in accordance with the royalty agreement. There is no other evidence or document in the record that suggests petitioner or Crocus represented to respondent that they conducted foreign trade shows as a joint venture.
The evidence indicates that petitioner represented to the great majority of exhibitors that it conducted foreign trade shows independently with no partner. Petitioner itself negotiated and entered into all contracts with exhibitors located outside the former Soviet Union, which accounted for 90 percent of trade show fees. If an exhibitor were to cancel a contract with petitioner, petitioner was entitled to retain all payments received as liquidated damages. Nothing in the record indicates Crocus was entitled to receive any potential liquidated damages retained by petitioner. At all foreign trade shows, petitioner's employees solicited exhibitors for future shows and provided liaison between exhibitors and Crocus's employees, thus indicating to the exhibitors that petitioner was in charge of the foreign trade shows.
Even though both petitioner and Crocus were parties to the cooperation agreement and trade show contracts with Expocentr, petitioner alone was obligated to pay rent and other fees for the use of the pavilions, and petitioner was the principal party in negotiations with Expocentr for the future use of pavilions. These contracts suggest that petitioner and Crocus did not represent themselves as a partnership or as joint venturers to Expocentr.
This Luna factor weighs against the finding of a joint venture between petitioner and Crocus during the taxable periods at issue.
7. Whether Separate Books of Account Were Maintained for the Venture
There is no evidence that separate books of account were maintained for a joint venture between petitioner and Crocus. Receipts, expenses, and other items with respect to foreign trade shows during the taxable periods at issue are recorded in petitioner's trial balances. However, the trial balances provide no indication that profits or losses were split between petitioner and Crocus. The record contains no corresponding trial balances for Crocus.
This Luna factor weighs against the finding of a joint venture between petitioner and Crocus during the taxable periods at issue.
Each party was responsible for paying its trade show expenses. Crocus was reimbursed for all its direct expenses by ECI. While both parties assumed mutual responsibilities for conducting the trade shows, there is no evidence Crocus had any control over the 90 percent of trade show receipts collected by petitioner and ECI. Under the contracts with Expocentr, petitioner was solely responsible for payments of rent for leasing pavilions. If an exhibitor located outside the former Soviet Union canceled a contract, petitioner alone could retain liquidated damages.
This Luna factor weighs against the finding of a joint venture between petitioner and Crocus during the taxable periods at issue.
Six of the eight Luna factors weigh against the finding of a joint venture; one Luna factor is neutral; and one Luna factor supports the finding of joint venture. Applying the various Luna factors, with no one factor being conclusive, we hold there was no joint venture between petitioner and Crocus to operate foreign trade shows during the taxable periods at issue.
We reach the same result using an overall or "gestalt" approach. Whether a joint venture exists depends ultimately on the intent of the parties. Commissioner v. Culbertson [49-1 USTC ¶ 9323], 337 U.S. 733 (1949); Commissioner v. Tower [46-1 USTC ¶ 9189], 327 U.S. 280 (1946). The trier of fact is to ascertain the parties' intent by "considering all the facts—the agreement, the conduct of the parties in execution of its provisions * * * and any other facts throwing light on their true intent". Commissioner v. Culbertson, supra at 742; Burde v. Commissioner [65-2 USTC ¶ 9733], 352 F.2d at 1002.
Considering all the facts and circumstances of this case that the parties have seen fit to reveal, we find that petitioner and Crocus did not intend to join together in the conduct of a joint venture or ventures to share profits or losses. Crocus was reimbursed for its trade show expenses by ECI; there is no evidence Crocus shared in the 25 percent of gross receipts allocated to and reported by petitioner under the royalty agreement. It was petitioner who conducted the trade show business in the United States, Russia, and elsewhere in Europe. Crocus's role was limited to assisting with the logistics of setting up and conducting the trade shows in the former Soviet Union and obtaining a few Russian exhibitors for those shows.
Although the "parties agree that no adverse inference should be drawn against either of them based on the ECI [royalty] agreement," the parties have neither filled nor illuminated the "black hole" that results from their removal of the royalty agreement and ECI from the picture. The removal of the royalty agreement and ECI does not uncover a subsisting joint venture or series of joint ventures between petitioner and Crocus.
We hold there was no joint venture between petitioner and Crocus to operate foreign trade shows during the taxable periods at issue.
Issue 2. In the Alternative, Whether and in What Amounts Petitioner Is Entitled to Additional Business Expense Deductions for the Taxable Periods at Issue, for Amounts Paid or Payable to Crocus as Compensation for Its Services in Operating the Foreign Trade Shows
Petitioner argues in the alternative that we should find that Crocus was entitled to a markup on its direct expenses as compensation for its services in operating the foreign trade shows. Petitioner claims a compensation deduction under section 162(a)(1) for amounts paid or payable to Crocus as a markup. Petitioner argues that we should estimate a markup paid or payable to Crocus as compensation for its services equivalent to 50 percent of the net profits for foreign trade shows held during the taxable periods at issue. Specifically, petitioner asks us to allocate Crocus a markup of $2,135,614.50 (50 percent of $4,271,229 net profit) for foreign trade shows conducted during the last 7 months of the fiscal year ended July 31, 1995, and $3,058,173 (50 percent of $6,116,346 net profit) for foreign trade shows conducted during the fiscal year ended July 31, 1996.
Respondent asks us to disregard the corporate entities of petitioner and Crocus. Respondent views their transactions at the stockholder level, in accordance with Article 10 of the stockholders' agreement, under which petitioner's net profits of foreign trade shows are to be allocated 50 percent to Agalarov, and the other 50 percent split between Pollak, Tseytin, and Kogan. Respondent argues that petitioner should not be allowed a markup to Crocus because Crocus was the alter ego of Agalarov who should receive his share of 50 percent of the net profits under the stockholders' agreement. Specifically, respondent asks us to allocate all gross receipts and expenses to petitioner, which would leave it with net profit of $4,271,229 for the last 7 months of the fiscal year ended July 31, 1995, and net profit of $6,116,346 for the fiscal year ended July 31, 1996. In respondent's view, Agalarov would then be allocated 50 percent of the net profits to be paid to him as a dividend, with the remaining profits allocated to and retained on behalf of the other three stockholders.
Petitioner argues that the stockholders' agreement was superseded by the royalty agreement.
We reject both petitioner's and respondent's arguments. We reject respondent's argument because a corporate entity generally will not be disregarded for tax purposes so long as it is formed for a substantial business purpose or actually engages in a business activity after its formation. Moline Props., Inc. v. Commissioner [43-1 USTC ¶ 9464], 319 U.S. 436, 439 (1943); O'Neill v. Commissioner [48-2 USTC ¶ 9406], 170 F.2d 596, 598 (2d Cir. 1948), affg. a Memorandum Opinion of this Court dated Aug. 8, 1947; Recklitis v. Commissioner [Dec. 45,154], 91 T.C. 874, 892 (1988). On the other hand, when a corporation is not formed for any significant, nontax business purpose, and does not engage in any substantive business activity, its existence will be disregarded for tax purposes, even though it may be validly incorporated under State law. Recklitis v. Commissioner, supra; Noonan v. Commissioner [Dec. 29,725], 52 T.C. 907, 910 (1969), affd. [71-2 USTC ¶ 9756] 451 F.2d 992 (9th Cir. 1971). In Natl. Carbide Corp. v. Commissioner [49-1 USTC ¶ 9223], 336 U.S. 422, 433 (1949), the Supreme Court refused to disregard the existence of a corporation even though it stated: "Undoubtedly the great majority of corporations owned by sole stockholders are `dummies' in the sense that their policies and day-to-day activities are determined not as decisions of the corporation but by their owners acting individually."
There is no evidence, nor has respondent directly argued, that the separate entity status of petitioner or Crocus should be disregarded. The stockholders' agreement is simply an agreement between stockholders to split petitioner's net profits in percentages that vary from the stockholders' stock ownership percentages. We reject petitioner's argument that the stockholders' agreement is superseded by the royalty agreement because there is no evidence that the stockholders have ever rescinded the stockholders' agreement or declared it invalid. Although we agree with respondent that the stockholders' agreement is still valid and in effect, it does not prove that petitioner or Crocus acted in such a way that their separate corporate status should be disregarded. Petitioner and Crocus were formed for substantial nontax business purposes and engaged in business activities, including conducting and providing services for trade shows. Petitioner, not its stockholders, conducted trade shows in the United States and the former Soviet Union. Crocus, not Agalarov, performed services in helping petitioner put on foreign trade shows. Third parties, including Expocentr and exhibitors, transacted business with petitioner and Crocus, not their stockholders. Petitioner never declared or paid dividends to any of its stockholders, and there is no evidence petitioner distributed profits under the stockholders' agreement to Agalarov or the other stockholders.
We see no evidence that petitioner and Crocus were formed for purely tax avoidance purposes. Petitioner's stockholders subjected themselves to two layers of U.S. income tax by forming petitioner as a separate corporate entity to conduct trade shows. It would not have been efficient, in the tax or economic sense, for petitioner to pay Agalarov for his services by declaring a dividend or making a distribution subject to double taxation. Rather, petitioner could receive a deduction from gross revenues either by paying Agalarov directly as an employee or by paying Crocus directly. Inasmuch as Crocus is a separate entity from petitioner, it is highly unlikely that Crocus would have performed services at foreign trade shows for nothing more than the reimbursement of its direct expenses. Although the disclosed arrangements between petitioner and Crocus are opaque, we see nothing in them that would justify the stretch respondent asks the Court to indulge in. We see no reason to disregard the separate corporate status of petitioner or Crocus.
Petitioner argues that Crocus should be allocated at least 50 percent of net profits reported in the stipulation of facts because Crocus paid more than 50 percent of the total foreign trade show expenses paid by petitioner and Crocus.
There is no evidence Crocus received, had any control over, or had rights to make withdrawals from the 90 percent of trade show receipts collected by petitioner and ECI. Petitioner's argument is undermined by the fact that Crocus did not bear the burden of its direct expenses because those expenses were reimbursed. Petitioner provided no information about the financial records of Crocus and ECI to substantiate its argument for a greater deduction or higher allocation of net profits to Crocus as a compensation deduction. We therefore reject petitioner's request to allocate to Crocus 50 percent or more of the net profits reported in the stipulation of facts.
Petitioner has presented no financial records of the business operations of ECI and Crocus. The incompleteness of the record has been aggravated by respondent's unexplained failure to follow through with discovery after the Court granted respondent's application for a letter of request authorizing a foreign deposition. The stipulated facts in this case present a mysterious world where real-life agreements are disregarded, financial records are nowhere to be found, and a myriad of other relevant information is absent. Although both petitioner and respondent have agreed that disregarding the royalty agreement and ECI should not have an adverse effect on either party, the "black hole" surrounding the financial operations of ECI and Crocus has impaired our ability to understand the business and financial relationships of petitioner and Crocus.
In the stipulation of facts, "the parties agree that the Court may characterize the relationship between petitioner and Crocus vis-a-vis foreign trade shows based solely on this Stipulation of Facts and the Exhibits attached hereto and the opposing party's admissions filed in this case." The stipulated record provides substantial evidence that Crocus performed significant and substantial services in operating the foreign trade shows. Inasmuch as Crocus is a separate entity from petitioner, it is highly unlikely that Crocus would have performed services at foreign trade shows for nothing more than the reimbursement of its direct expenses. We are mindful of the admonition of Judge Learned Hand in Commissioner v. Maresi [46-1 USTC ¶ 10,276], 156 F.2d 929, 931 (2d Cir. 1946), affg. [Dec. 15,051] 6 T.C. 582 (1946), that "The one sure way to do injustice in such cases is to allow nothing whatever upon the excuse that we cannot tell how much to allow." See also Gerling Intl. Ins. Co. v. Commissioner [Dec. 48,247], 98 T.C. 640, 659 (1992). Doing the best we can with the gap-riddled record the parties have created, we find that fees collected by Crocus during the taxable periods at issue from exhibitors located in the former Soviet Union were retained by Crocus as compensation for its services in operating the foreign trade shows. Inasmuch as it may fairly be inferred and we do find that such fees have been included in petitioner's gross income under the stipulation of the parties, petitioner is entitled to deduct the amount of such fees from its gross income under section 162(a)(1).
There is no evidence to suggest that ECI's reimbursements to Crocus were reduced by the fees collected by Crocus. There is no evidence to suggest Crocus remitted such fees to either ECI or petitioner.
We find that fees collected by Crocus during the taxable periods at issue from exhibitors located in the former Soviet Union were retained by Crocus. We also find that fees collected and retained by Crocus from exhibitors domiciled in the former Soviet Union were available to pay Crocus's overhead expenses with respect to foreign trade shows.
Unlike the inherently vague stipulation of facts for preJanuary 1, 1995, foreign trade shows, petitioner and respondent stipulated "the total gross revenues from exhibition fees for foreign trade shows" conducted during the taxable periods at issue to be included in petitioner's gross income. It may fairly be inferred from the stipulation that "total gross revenues from exhibition fees for foreign trade shows" includes fees collected and retained by Crocus from exhibitors located in the former Soviet Union.
Our conclusion is consistent with and confirmed by the notion that Crocus would also be entitled to compensation for operating the foreign trade shows under common law principles of agency and quantum meruit. Section 441 of the Restatement (Second), Agency (1958) states:
A plaintiff may recover "in quantum meruit `to assure a just and equitable result,' * * * where `the defendant received a benefit from the plaintiff's services under circumstances which, in justice, preclude him from denying an obligation to pay for them'". Rule v. Brine, Inc., 85 F.3d 1002, 1011 (2d Cir. 1996) (quoting Bradkin v. Leverton, 26 N.Y.2d 192, 196 (1970); see also Restatement, Restitution, sec. 112 (1937)).
Petitioner requested and received Crocus's services in helping petitioner conduct foreign trade shows. Respondent acknowledges Crocus's services were substantial and significant. Because Crocus's sole owner, Agalarov, owns only a 33.33-percent minority interest in petitioner, petitioner and Crocus are not sufficiently related to assume Crocus would provide its services to petitioner for nothing more than the reimbursement of its direct expenses, and there is no evidence to suggest otherwise.
It may fairly be inferred from the stipulated record that petitioner requested Crocus's services because Crocus had the expertise and support staff necessary to conduct trade shows in the former Soviet Union. The services provided by Crocus were necessary to operate the foreign trade shows. Crocus was also responsible for relations with exhibitors located in the former Soviet Union, including collecting fees from such exhibitors. It may fairly be inferred that one purpose of the foreign trade shows was to increase mutual contacts and provide networking opportunities for exhibitors located outside the former Soviet Union to establish business relationships with companies in the former Soviet Union. Although fees collected from exhibitors located in the former Soviet Union accounted for only 10 percent of all trade show receipts, the attendance of such exhibitors at foreign trade shows no doubt increased networking opportunities for exhibitors located outside the former Soviet Union, thereby making the trade shows more attractive to them.
Because services provided by Crocus were essential to conduct and increase the profitability of the foreign trade shows, it may fairly be inferred that petitioner or ECI made arrangements for Crocus to receive some payment for its services in addition to the reimbursement of its direct expenses of operating the foreign trade shows.
Crocus's compensation consisted of a portion of the gross revenues from foreign trade shows, which was contingent on the amount of fees Crocus collected from exhibitors located in the former Soviet Union. For foreign trade shows conducted during the last 7 months of the fiscal year ended July 31, 1995, Crocus's compensation of 10 percent of gross revenues amounted to $1,307,122 (10 percent of gross revenues of $13,071,216). For foreign trade shows conducted during the fiscal year ended July 31, 1996, Crocus's compensation of 10 percent of gross revenues amounted to $2,068,759 (10 percent of gross revenues of $20,687,586). Petitioner is entitled to deduct the amount of such fees collected by Crocus during the taxable periods at issue from exhibitors located in the former Soviet Union as reasonable compensation to Crocus for its services in operating the foreign trade shows.
The result of our holdings is that petitioner is entitled to deduct 30.6 percent and 33.8 percent, respectively, of the stipulated net profits of the foreign trade shows for the 7 months ended July 31, 1995, and the fiscal year ended July 31, 1996, as compensation to Crocus.
In summary, we hold that petitioner and Crocus were not engaged in a joint venture during the taxable periods at issue; petitioner must therefore report all revenues from foreign trade shows collected by petitioner or ECI during the taxable periods at issue. Petitioner may deduct its direct expenses, the Expocentr rent expenses, and Crocus's reimbursed direct expenses, all in accordance with the stipulation of the parties. Petitioner is also entitled to deduct the amount of fees collected by Crocus during the taxable periods at issue from exhibitors located in the former Soviet Union as reasonable compensation
To give effect to the foregoing,
Decision will be entered under Rule 155.
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