Rev. Rul. 80-42

1980-1 C.B. 182, 1980-7 I.R.B. 14.

                       Internal Revenue Service
                                 Revenue Ruling

              BASIS; FILM RIGHTS; COST EXCEEDING FAIR MARKET VALUE

                          Published: February 19, 1980

Section 1011.--Adjusted Basis for Determining Gain or Loss, 26 CFR 1.1011-1: Adjusted basis.

  Basis; film rights; cost exceeding fair market value. A corporation purchased certain motion picture exhibition rights in an arm's length transaction and resold them to a limited partnership whose general partner was the corporation's majority shareholder for a cash down-payment greater than the corporation's original cost plus a nonrecourse note. The partnership is unable to demonstrate that the fair market value of the rights exceeds the corporation's original cost, and the partnership's basis in the rights is limited to their fair market value.

ISSUE

  What is the basis of the motion picture exhibition rights for federal income tax purposes under the circumstances described below, where the cash downpayment for the rights is in excess of their fair market value?

FACTS

  On October 15, 1979, X, a limited partnership, acquired the rights from M, a corporation, to exhibit a completed motion picture in the United States.  A, the general partner of X, is a majority shareholder of M, but there is no relationship between M and the limited partners of X.  X uses the accrual method of accounting.  The purchase agreement between X and M stated that the purchase price was 2,000x dollars.  The stated purchase price was agreed upon in order to establish a higher basis for the property.  Pursuant to the agreement, X paid 500x dollars on delivery of the film rights and gave a note to M in the face amount of 1,500x dollars.  As collateral for the note, X gave M a security interest in the film rights and in one-half the net receipts earned from exploitation of the film.  The note was non-negotiable, bearing interest at the annual rate of eight percent with principal and interest due and payable on October 14, 1983.  Prepayment of principal and interest was required to the extent of 50 percent of the net receipts derived from distribution of the picture.

  Neither X nor any of the partners of X was personally liable for payment of the note.  The sole recourse of M in the event of default was to the collateral securing the note.

  The motion picture had been produced in a foreign country. M had acquired the United States exhibition rights from the foreign producer in an arm's length transaction for 400x dollars a few months before transferring the rights to X. X is unable to demonstrate that the fair market value of the acquired rights exceeded 400x dollars.

LAW AND ANALYSIS

  Section 1011(a) of the Internal Revenue Code provides that, in general, the adjusted basis for determining gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under section 1012, adjusted as provided in section 1016.

  Section 1012 of the Code provides that, in general, the basis of property shall be its cost.

  In Rev. Rul. 77-110, 1977-1 C.B. 58, the Service concludes that the liability on a nonrecourse interest-bearing note given as part of the purchase price of film distribution rights, whose value could not be shown to approximate the amount of the note, may not be included in the basis of the rights and no deduction is allowable for interest accrued on the note.

  In this case, x is unable to establish that the fair market value of the film rights purchased from M exceeds 400x dollars.  The burden is on X to prove that the payment to M for the film rights that is in excess of their fair market value is not for a purpose other than the acquisition of the film rights. See Majestic Securities Corp. v. Commissioner, 120 F.2d (8th Cir. 1941), aff'g 42 B.T.A. 698 (1940); and New Hampshire Fire Insurance Co. v. Commissioner, 2 T.C. 708 (1943).

HOLDING

  The cash payment made by X to M that is in excess of the fair market value of the film exhibition rights may not be included in the basis of the film rights.  The basis of the film rights purchased by X is limited to their fair market value.

  Consistent with Rev. Rul. 77-110, the liability created by the nonrecourse note given by X to M may not be included in the basis of the film rights.

Rev. Rul. 80-42, 1980-1 C.B. 182, 1980-7 I.R.B. 14.