Chickie's & Pete's Inc. v. Comm'r

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge: Respondent determined a deficiency of $ 304,328 in petitioner's Federal income tax for the taxable year ended June 30, 2000 (year at issue).

We must decide whether petitioner is entitled to deduct for the year at issue the portion of a $ 902,476 payment that it made to its sole stockholder and officer in excess of the amount of such payment that respondent concedes petitioner may deduct. ¹ We hold that it is not.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

At the time of the filing of the petition in this case, petitioner's principal place of business was in Philadelphia, Pennsylvania.

In May 1999, the name "Chickie's and Pete's" was registered with the United States Patent and Trademark Office*243 (U.S.Patent and Trademark office). ² On or about September 1, 1999, petitioner began operating a bar/restaurant under that name on Roosevelt Avenue in Philadelphia, Pennsylvania (Philadelphia). At all relevant times, Peter Ciarrocchi, Jr. (Mr. Ciarrocchi), was petitioner's sole stockholder and officer, as well as the sole stockholder and officer of 4010, Inc., which operated a bar/restaurant under the name "Chickie's and Pete's" on Robbins Avenue in Philadelphia.

On April 12, 1999, 4010, Inc., and Ogden Entertainment, Inc. (Ogden), which was operating food and beverage concessions at Veterans Stadium in Philadelphia (Ogden's Veterans Stadium concessions), entered into a license agreement (Ogden license agreement). That agreement provided in pertinent part:

   WHEREAS, Licensee [Ogden] operates the food and beverage

   concessions at Veterans Stadium in Philadelphia, *244 Pennsylvania

   ("Veterans Stadium");

   WHEREAS, Licensee desires the right to use the Trademark [i.e.,

   "CHICKIE'S & PETE'S" and the goodwill associated

   therewith] and the recipes and menu items developed, formulated

   and tested by Licensor [4010, Inc.] (such recipes and menu items

   being the "Licensed Rights") at its location at 4010

   Robbins Avenue, Philadelphia * * * to identify the goods and

   services being licensed to Licensee under this Agreement (the

   "Business"); and

   WHEREAS, Licensor is willing to grant to Licensee a non-

   exclusive license to use the Trademark and the Licensed Rights

   in the identification and operation of Licensee's Business

   pursuant to the provisions contained in this Agreement.

   NOW, THEREFORE, in consideration of the mutual covenants and

   promises hereinafter set forth, the parties, intending to be

   legally bound, hereby agree as follows:

     1. Grant of License.

   (a) Licensor hereby grants to Licensee, subject to the

   provisions of this Agreement, the non-exclusive license to use

   the*245 Trademark and such other variations of the Trademark as may

   be authorized by Licensor in the operation of a food service

   business together with the Licensed Rights only at * * *

   Veterans Stadium (the "License"). * * *

   (b) Except as set forth in Paragraph 1(a) above, this Agreement

   shall in no way limit Licensor's use of the Trademark or the

   Licensed Rights in its current operation or in any future

   endeavor which Licensor may pursue or desire to pursue,

   including but not limited to, operating or licensing others to

   operate Chickie's & Pete's concessions in any other stadium,

   arena or other similar venue.

   (c) In consideration for the granting of this License, Licensee

   shall make the following payments to Licensor at the times and

   in the manner set out below:

     (i) Licensee shall pay a one-time fee of Ten Thousand

     Dollars ($ 10,000.00) as an initial License fee which fee

     shall be paid no later than the execution of this

     Agreement, at which time it shall be deemed fully earned,

     due and payable. *246 The initial License Fee is not refundable

     under any circumstances.

     (ii) As a continuing fee ("Royalty") on or before

     Tuesday of each week during the term of this Agreement,

     Licensee shall pay to Licensor a sum equal to eleven

     percent (11%) of the Gross Sales for the seven (7) day

     period ending at the close of business on the Sunday

     preceding such Tuesday.

        (A) The term "Gross Sales" means all of

        Licensee's receipts from operations, sales, charges,

        fees, orders taken, services, concessions, business

        interruption insurance and all other revenues of any

        kind and nature, whether for cash or credit, in, from,

        about or by reason of the operation of Licensee's

        Business under the Trademark and Licensed Rights but

        excludes inter-company transfers, bona fide credits

        and refunds upon return of merchandise, discounts,

        tips, the value of any coupon, voucher*247 or allowance

        issued or granted to a customer of a restaurant in

        furtherance of any promotional program and which is

        received and credited in full or partial payment for

        products or services sold at the Business and amounts

        collected and turned over by Licensee for use tax,

        sales tax, excise tax and all other similar taxes

        (other than taxes on net income) levied by any

        governmental body.

     2. Licensee's Obligations and Undertakings.

   (a) * * * Licensee covenants and agrees, as part of the

   consideration of the issuance of this License by Licensor, that

   Licensee:

           *   *   *   *   *   *   *

     (ii) shall serve all of the menu items specified by

     Licensor as set forth on Schedule 2(a)(ii) attached hereto

     and made a part hereof ³ and shall serve only

     such menu items as are specified by Licensor, and shall

     follow all specifications and formulae*248 of Licensor as to

     the contents, quality and weight of the unit or products

     served. In order to assure that Licensee operates in strict

     accordance with such standards, Licensee shall purchase the

     goods listed on Schedule 2(a)(ii) attached directly from

     Licensor or from such sources as Licensor may designate in

     writing from time to time; * * *

           *   *   *   *   *   *   *

     3. Licensor's Obligations.

     Licensor agrees to provide at its own expense:

   (a) an on-site manager to train License[e] and/or its employees

   and staff on food production, customer service, staffing and

   training; and

   (b) all materials and information needed by Licensee to open and

   maintain the Business using the Trademarks and Licensed Rights,

   other than inventory to be used or consumed by Licensee in the

   operation of the Business.

*249 Except for an initial training session that Mr. Ciarrocchi provided for Ogden personnel, neither Mr. Ciarrocchi nor any other employee of 4010, Inc., had any involvement in the management or operation of the Ogden's Veterans Stadium concessions.

On September 1, 1999, Mr. Ciarrocchi and petitioner entered into a license agreement (petitioner's license agreement). That agreement provided in pertinent part:

   WHEREAS, Licensee [petitioner] operates the food and beverage

   bar/restaurant at 10100 Roosevelt Boulevard, Philadelphia;

   WHEREAS, Licensee desires the right to use the Trademark [i.e.,

   CHICKIE'S & PETE'S and the goodwill associated therewith] and

   the recipes and menu items developed, formulated and tested by

   Licensor [Mr. Ciarrochi] (such recipes and menu items being the

   "Licensed Rights") at its location at 4010 Robbins

   Avenue, Philadelphia * * * to identify the goods and services

   being licensed to Licensee under this Agreement (the

   "Business"); and

   WHEREAS, Licensor is willing to grant to Licensee a non-

   exclusive license to use the Trademark and the Licensed Rights

*250    in the identification and operation of Licensee's Business

   pursuant to the provisions contained in this Agreement.

   NOW, THEREFORE, in consideration of the mutual covenants and

   promises hereinafter set forth, the parties, intending to be

   legally bound, hereby agree as follows:

     1. Grant of License.

   (a) Licensor hereby grants to Licensee, subject to the

   provisions of this Agreement, the non-exclusive license to use

   the Trademark and such other variations of the Trademark as may

   be authorized by Licensor in the operation of a food service

   business together with the Licensed Rights only at * * * 10100

   Roosevelt Boulevard, Philadelphia * * * (the "License").

   * * *

   (b) In consideration for the granting of this License, Licensee

   shall make the following payments to Licensor at the times and

   in the manner set out below:

     (i) Licensee shall pay as a continuing fee

     ("Royalty") periodically each year Twenty-two and

     one-half percent (22.5%) of the Gross Sales for the yearly

     period*251 September 1st through August 31 st eachyear.

        (A) The term "Gross Sales" means all of

        Licensee's receipts from operations, sales, charges,

        fees, orders taken, services, concessions, business

        interruption insurance and all other revenues of any

        kind and nature, whether for cash or credit, in, from,

        about or by reason of the operation of Licensee's

        Business under the Trademark and Licensed Rights but

        excludes intercompany transfers, bona fide credits and

        refunds upon return of merchandise, discounts, tips,

        the value of any coupon, voucher or allowance issued

        or granted to a customer of a restaurant in

        furtherance of any promotional program and which is

        received and credited in full or partial payment for

        products or services sold at the Business and amounts

        collected and turned over by Licensee for use tax,

        sales tax, excise*252 tax and all other similar taxes

        (other than taxes on net income) levied by any

        governmental body.

     2. Licensee's Obligations and Undertakings.

   (a) * * * Licensee covenants and agrees, as part of the

   consideration of the issuance of this License by Licensor, that

   Licensee:

           *   *   *   *   *   *   *

     (ii) shall serve all of the menu items specified by

     Licensor as set forth on Schedule 2(a)(ii) attached hereto

     and made a part hereof ⁴ and shall serve only

     such menu items as are specified by Licensor, and shall

     follow all specifications and formulae of Licensor as to

     the contents, quality and weight of the unit or products

     served. In order to assure that Licensee operates in strict

     accordance with such standards, Licensee shall purchase the

     goods listed on Schedule 2(a)(ii) attached directly from

     Licensor or from such sources as Licensor may designate in

     writing from time to*253 time; * * *

           *   *   *   *   *   *   *

     3. Licensor's Obligations.

     Licensor agrees to provide at its own expense:

   (a) an on-site manager to train Licensee and/or its employees

   and staff on food production, customer service, staffing and

   training; and

   (b) all materials and information needed by Licensee to open and

   maintain the Business using the Trademarks and Licensed Rights,

   other than inventory to be used or consumed by Licensee in the

   operation of the Business.

During the year at issue, Mr. Ciarrocchi performed a variety of services for petitioner, including: (1) Designing the layout of petitioner's bar/restaurant, (2) developing the food products to be served at petitioner's bar/restaurant, (3) hiring all the employees of petitioner's bar/restaurant,*254 and (4) ordering all the supplies for petitioner's bar/restaurant.

During the last six months of the year at issue, petitioner paid Mr. Ciarrocchi a so-called royalty fee of $ 902,476 under petitioner's license agreement (payment under petitioner's license agreement). During the year at issue, petitioner also paid Mr. Ciarrocchi a salary of $ 18,000 and a management fee of $ 90,000.

Petitioner filed Form 1120, U.S. Corporation Income Tax Return, for the year at issue. In that return, petitioner, inter alia, claimed a deduction of $ 902,476 for the payment under petitioner's license agreement.

Respondent issued a notice of deficiency (notice) to petitioner. In the notice, respondent determined to disallow the deduction of $ 902,476 that petitioner claimed for the payment under petitioner's license agreement.

OPINION

Although respondent must have commenced respondent's examination of petitioner's return for the year at issue after July 22, 1998, the parties do not address section 7491(a). ⁵ On the record before us, we find that petitioner has failed to carry its burden of establishing that it satisfied the applicable requirements of section 7491(a)(2). On that record, we conclude*255 that petitioner's burden of proof, see Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115, 78 L. Ed. 212, 54 S. Ct. 8, 1933-2 C.B. 112 (1933), does not shift to respondent under section 7491(a). Moreover, with respect to the deduction that petitioner is claiming for the year at issue, deductions are strictly a matter of legislative grace, and petitioner bears the burden of proving that it is entitled to the deduction claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84, 117 L. Ed. 2d 226, 112 S. Ct. 1039 (1992).

On brief, respondent concedes that petitioner is entitled to deduct as a royalty fee for the year at issue $ 441,210 of the $ 902,476 that petitioner claimed as a deduction for the payment under petitioner's license agreement. ⁶ However, it is respondent's position that petitioner has failed to establish that it is entitled to a deduction in excess of the amount that respondent*256 concedes. In support of that position, respondent asserts:

   Mr. Ciarrocchi testified that he believed that petitioner should

   pay a higher royalty fee than Ogden [paid under the Ogden

   license agreement] because he had developed additional recipes

   for petitioner's use * * *. However, both agreements [the Ogden

   license agreement and petitioner's license agreement] contain

   the same terms concerning the use of Mr. Ciarrocchi's family

   recipes. There is nothing in the Ogden licensing agreement that

   limits the number of recipes covered by the agreement, nor did

   Mr. Ciarrocchi testify that there were any such limitations.

   Therefore, there is no basis for concluding that the right

   granted to petitioner under * * * [petitioner's] license

   agreement to use Mr. Ciarrocchi's recipes had any greater value

   than the same right granted to Ogden under * * * [Ogden's

   license] agreement * * *. To the extent that Mr. Ciarrocchi

   provided services to petitioner that he did not provide to

   Ogden, he did so as an officer and employee of petitioner and

   not pursuant*257 to the license agreement.

           *   *   *   *   *   *   *

   Finally, there is no evidence in the record to support

   petitioner's contention that the disallowed portion of the

   royalty fee should be treated as deductible compensation for

   services rendered. While I.R.C. section 162(a)(1) allows a

   taxpayer to deduct compensation paid, the taxpayer must

   establish that the parties intended the payment to be

   compensation for services rendered, and that the amount paid is

   reasonable. * * * Here, since the payment was made pursuant to *

   * * [petitioner's] license agreement, it is clear that it was

   not intended as compensation for the services Mr. Ciarrocchi

   rendered as petitioner's officer/employee * * *.

   In any event, petitioner has provided no evidence to support the

   contention that it would be reasonable to allow additional

   compensation exceeding the $ 108,000 Mr. Ciarrocchi received as

   salary and management fees from petitioner for the services he

   performed as petitioner's officer and employee. *258 If the balance

   [i.e., $ 461,266] of the royalty fee exceeding the amount

   conceded by respondent is allowed as compensation, then Mr.

   Ciarrocchi's compensation for the taxable year ended June 30,

   2000 would be $ 569,266. * * * the record contains no frame of

   reference from which to even begin the analysis the courts

   engage in when determining whether compensation is reasonable

   and, thus, deductible under section 162(a)(1). [Fn. ref. omitted.]

It is petitioner's position that it is entitled to deduct the entire $ 902,476 payment under petitioner's license agreement, and not just the $ 441,210 that respondent concedes. In support of that position, petitioner asserts:

   taxpayer [petitioner] is providing royalties to the person [Mr.

   Ciarrocchi] who provided Italian recipes, and traditional family

   information, along with trade secrets and methods in operating

   this type of restaurant. The amount paid to Mr. Ciarrocchi by

   the taxpayer was and is reasonable.

   It is well established that for a payment to be deductible, the

   payer must have intended the payment to be compensation*259 for

   services rendered and it must be reasonable in amount. * * *

   The complete test for royalty fees is that they are fair and

   reasonable and are paid for services rendered. * * *

   Mr. Ciarrocchi had entered into a fair and reasonable, arm's-

   length license agreement with Ogden Entertainment prior into

   [sic] his entering into a fair and reasonable license agreement

   with the taxpayer [petitioner]. Since Ogden was willing to pay

   11% of gross revenues (plus a $ 10,000.00 up-front bonus) to Mr.

   Ciarrocchi for his minimal participation, then the taxpayer in

   this matter should have expected to pay much more for Mr.

   Ciarrocchi's full participation and creativity.

*260 In further support of petitioner's position, petitioner asserts:

   Ogden was permitted to use the name "Chickie's and

   Pete's" and the "Crabfries(R)" product only;

   Chickie's and Pete's, Inc. [petitioner] was permitted to use the

   name, and all of the many and varied products, recipes, spices

   and techniques. These additional items should more than

   double, and maybe even triple, the amount of royalty paid by

   Petitioner. The higher percentage royalty for a larger amount

   and variety of items is "fair and reasonable". * * *

We turn first to petitioner's contention that, pursuant to the Ogden license agreement, Ogden was allowed to use, in addition to the name "Chickie's and Pete's", only the "Crabfries(R)" product, and not any of the other "many and varied products, recipes, spices and techniques" that petitioner claims it was permitted to use under petitioner's license agreement. On the record before us, we reject that contention. Ogden's license agreement did not in any way limit the products of Chickie's and Pete's that Ogden was permitted to sell at Ogden's Veterans Stadium concessions. ⁷ In fact, Mr. Ciarrocchi's*261 testimony establishes that there was no limit on the products that Ogden was permitted to use under Ogden's license agreement. Mr. Ciarrocchi testified:

   With the development of the products and Chickie's and Pete's,

   we opened up in Veteran's [sic] Stadium in April of 1999 and I

   went into an agreement that you spoke of before with Ogden

   [i.e., Ogden's license agreement] * * * where I would sell my

   products at the stadium * * * they would use my name, my recipes

   and they would pay me a royalty for using them.

           *   *   *   *   *   *   *

   * * * Ogden Entertainment, they came to me and asked if they * *

   * could sell my products in their stadium and I said, sure.

   That'd be great and we discussed the price and we negotiating

   [sic] how much it would cost.

   It was 11 percent of the gross sales of the stadium of

   anything that was sold with the Chickie's and Pete's name * * *.

*262 We turn now to petitioner's contentions that Mr. Ciarrocchi performed more services for petitioner under petitioner's license agreement than 4010, Inc., performed for Ogden under Ogden's license agreement and that consequently it was reasonable for Mr. Ciarrocchi to receive 22-1/2 percent of gross sales under petitioner's license agreement, instead of 11 percent of gross sales, which was the fee that 4010, Inc., was to receive under Ogden's license agreement.⁸ Although not altogether clear, it appears that petitioner may be arguing that it made a portion of the $ 902,476 payment under petitioner's license agreement in order to compensate Mr. Ciarrocchi for services rendered to petitioner and that that portion is deductible under section 162(a)(1). A payment is deductible as compensation under section 162(a)(1) if it is for services actually rendered to the payor in or before the year of payment and is reasonable in amount. ⁹ E.g., Lucas v. Ox Fibre Brush Co., 281 U.S. 115, 119, 74 L. Ed. 733, 50 S. Ct. 273 (1930); sec. 1.162-7(a), Income Tax Regs. On the record before us, we find that petitioner has failed to carry its burden of showing that any portion of the $ 902,476*263 payment that it made to Mr. Ciarrocchi in excess of the amount that respondent concedes is deductible as a royalty under section 162(a)(3) constitutes compensation for services rendered that is deductible under section 162(a)(1).

*264 Based upon our examination of the entire record before us, we find that petitioner has failed to carry its burden of establishing that it is entitled to deduct for the year at issue the portion of the $ 902,476 payment under petitioner's license agreement in excess of the amount that respondent concedes.

We have considered all of the contentions and arguments of the parties that are not discussed herein, and we find them to be without merit, irrelevant, and/or moot.

To reflect the foregoing and the concession of respondent,

Decision will be entered under Rule 155.