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Petitioner issued a credit to the customer in the amount of
$7,095 to adjust for the prior overbilling.
OPINION
The primary issue for our consideration is whether
petitioner's royalty payments to DM were reasonable in amount.
To the extent petitioner's payments to DM are disallowed as
royalties, petitioner argues that it is entitled to deduct the
payments under section 162 as payments to a charitable
organization in expectation of commensurate financial benefit.
Taxpayers are entitled to deduct royalty expenses incurred
in carrying on a trade or business that are reasonable in amount
under section 162(a)(3). Sierra Club Inc. v. Commissioner, 86
F.3d 1526, 1531 (9th Cir. 1996), affg. in part and revg. in part
103 T.C. 307 (1994); Surloff v. Commissioner, 81 T.C. 210, 232
(1983); Differential Steel Car Co. v. Commissioner, 16 T.C. 413,
423 (1951). Reasonableness is a question of fact to be
determined from all the facts and circumstances. Petitioner
bears the burden of proving the reasonableness of royalty
payments. Rule 142(a); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934). Respondent agrees that petitioner may
deduct the royalty payments under section 162(a)(3) to the extent
they were reasonable.
Royalty payments between related parties require special
scrutiny to determine whether they are reasonable in amount.
Royalty payments are reasonable if an unrelated third party
dealing at arm's length would have agreed to the payments.
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