Dharma Enterprises - Page 15

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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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