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Petitioner bears the burden of proof in this case. Rule
142(a). The regulations in question, sec. 1.451-3(e), Income Tax
Regs., provide the Commissioner with the ability to treat one
agreement as several contracts for the purpose of clearly
reflecting income. Respondent's authority in the context of
these regulations is to be judged on an abuse of discretion
standard. Sierracin Corp. v. Commissioner, 90 T.C. 341, 368
(1988). That standard was described in Sierracin as follows:
Section 446(b) and sections 1.451-3(e), 1.446-
1(a)(2), and 1.446-1(b)(1), Income Tax Regs., vest
respondent with broad discretion in determining whether
a taxpayer’s contracts should be severed so as to
clearly reflect income. “Since the Commissioner has
‘[m]uch latitude for discretion,’ his interpretation of
the statute's clear reflection standard ‘should not be
interfered with unless clearly unlawful.’” Thor Power
Tool Co. v. Commissioner, 439 U.S. 522, 532 (1979),
quoting Lucas v. American Code Co., 280 U.S. 445, 449
(1930). To overcome respondent's determination,
petitioner must establish that respondent was plainly
arbitrary in severing petitioner's contracts * * *.
See Reco Industries, Inc. v. Commissioner, 83 T.C. at
920; Peninsula Steel Products & Equip. Co. v.
Commissioner, 78 T.C. at 1046. * * * [Id.; fn. ref.
omitted.]
To prevail here, petitioner must show that there was no adequate
basis in law and/or fact for respondent's determination, i.e.,
that respondent's exercise of the regulatory discretion was
arbitrary or capricious. Ford Motor Co. v. Commissioner, 102
T.C. 87, 91-92 (1994), affd. 71 F.3d 209 (6th Cir. 1995).
A. Background--Completed Contract Method
The completed contract method of accounting for long-term
contracts first appeared in regulations issued under the Revenue
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