                                                                         RECOMMENDED FOR FULL-TEXT PUBLICATION
16   Kenco Restaurants, et al.                 Nos. 98-2416/                  Pursuant to Sixth Circuit Rule 206
     v. Commissioner                         2417/2418/2420          ELECTRONIC CITATION: 2000 FED App. 0057P (6th Cir.)
                                                                                 File Name: 00a0057p.06

failure to make a reasonable attempt to comply with the
provisions of this title . . . .” I.R.C. § 6662(c). It has also   UNITED STATES COURT OF APPEALS
been defined as a “lack of due care or a failure to do what a
reasonable and prudent person would do under the                                FOR THE SIXTH CIRCUIT
circumstances.” Hofstetter v. Commissioner, 98 T.C. 695,                          _________________
704 (1992). We find and conclude that Petitioners allocated
BKK’s management fees on the ability of each Group
                                                                                             ;
member to pay.
                                                                                              
                                                                  KENCO RESTAURANTS, INC.
                                                                                              
                                                                  (98-2416); K-K
                                                                                              
                                                                  RESTAURANTS, INC.
                                                                                              
                                                                                                        Nos. 98-2416/
                                                                  (98-2417); TIFFIN AVENUE
                                                                                              
                                                                                                        2417/2418/2420
                                                                  REALTY COMPANY, INC.         >
                                                                  (98-2418); BRYAN REALTY,    
                                                                                              
                                                                                              
                                                                  INC. (98-2420),

                                                                                              
                                                                         Petitioners-Appellants,
                                                                                              
                                                                                              
                                                                           v.
                                                                                              
                                                                                              
                                                                                              
                                                                  COMMISSIONER OF INTERNAL

                                                                        Respondent-Appellee. 
                                                                  REVENUE,

                                                                                              
                                                                                             1

                                                                       On Appeal from the United States Tax Court.
                                                                      Nos. 95-15949; 95-15950; 95-15951; 95-15952
                                                                               Argued: December 10, 1999
                                                                           Decided and Filed: February 16, 2000




                                                                                             1
2       Kenco Restaurants, et al.                    Nos. 98-2416/        Nos. 98-2416/                    Kenco Restaurants, et al.        15
        v. Commissioner                            2417/2418/2420         2417/2418/2420                          v. Commissioner

Before: BOGGS and SUHRHEINRICH, Circuit Judges;                           so did its fees.5 GMK’s fees increased more than 900%
            POLSTER, District Judge.*                                     between 1990 and 1992, and its share of the total fees
                                                                          increased by a factor of seven. However, no evidence was
                      _________________                                   presented that there was a corresponding increase in Owner
                                                                          hours. In 1990, Kenco required special attention to rebuild
                            COUNSEL                                       the restaurant. Yet, in 1991, the fee allocated to it was higher
                                                                          than 1990. There is no claim that K-K required special
ARGUED: John D. Steffan, STEFFAN & ASSOCIATES,                            attention in 1992, but its fee was higher in 1992 than in 1991.
Fairfax, Virginia, for Appellants. Charles F. Marshall, U.S.              Perrysburg was charged $29,000 in 1990, $60,415 in 1991,
DEPARTMENT OF JUSTICE, APPELLATE SECTION                                  and $42,700 in 1992, but Petitioners provided no explanation,
TAX DIVISION, Washington, D.C., for Appellee.                             in terms of services, that would account for these differences.
ON BRIEF: John D. Steffan, STEFFAN & ASSOCIATES,
Fairfax, Virginia, for Appellants. Charles F. Marshall, Teresa               The third issue we address is whether Petitioners are liable,
E. McLaughlin, U.S. DEPARTMENT OF JUSTICE,                                under § 6662(a) of the Internal Revenue Code, for accuracy-
APPELLATE SECTION TAX DIVISION, Washington, D.C.,                         related penalties due to their negligence. Petitioners contend
for Appellee.                                                             that the facts do not support the imposition of negligence
                                                                          penalties because Petitioners never made adjustments based
                      _________________                                   upon the ability or inability of a Group member to pay.
                                                                          However, the Commissioner contends that Petitioners
                          OPINION                                         allocated fees based on each Group member’s ability to pay.
                      _________________
  SUHRHEINRICH, Circuit Judge. The Commissioner of                            We review an imposition of § 6662(a) “negligence”
the Internal Revenue Service (“Commissioner”) sent                        penalties for clear error. See Leuhsler v. Commissioner, 963
Petitioners notices of deficiency that reallocated fees                   F.2d 907, 910 (6th Cir. 1992); see also Sacks v.
Petitioners paid for management and administrative services.              Commissioner, 82 F.3d 918, 920 (9th Cir. 1996).
The notices of deficiency also imposed accuracy-related                   “Commissioner’s assessment of a negligence penalty is
penalties. Petitioners filed separate petitions in the United             presumptively correct, and the taxpayer has the burden of
States Tax Court seeking a redetermination of the deficiencies            proving that an underpayment was not due to his negligence
and accuracy-related penalties.                                           . . . .” Leuhsler, 963 F.2d at 910.

  The tax court sustained the reallocations and penalties                    If there is an underpayment of tax on a return, a penalty in
because Petitioners failed to overcome the presumption of                 the amount of twenty percent of the underpayment is
correctness afforded to the notices of deficiency. Petitioners            imposed. See I.R.C. § 6662(a). This applies to the portion of
appeal. We AFFIRM.                                                        the underpayment that is attributable to negligence. See
                                                                          I.R.C. § 6662(b)(1). “Negligence” is defined to include “any

                                                                              5
    *                                                                          The Tax Court suspected “that Wapak’s insufficient cash-flow was
     The Honorable Dan A. Polster, United States District Judge for the   the determinant factor in BKK’s management decision not to allocate
Northern District of Ohio, sitting by designation.                        Wapak a management fee in 1990.” We agree.
14   Kenco Restaurants, et al.                 Nos. 98-2416/      Nos. 98-2416/                 Kenco Restaurants, et al.      3
     v. Commissioner                         2417/2418/2420       2417/2418/2420                       v. Commissioner

Petitioners must show that their own allocations reflect an                                     I.
arm’s-length charge.      See DHL Corp. & Subs. v.
Commissioner, 76 T.C.M. (CCH) 1122, 1145 (1998); see also           Petitioners-Appellants, Kenco Restaurants, Inc. (“Kenco”);
Treas. Reg. § 1.482-1(b). This is accomplished by providing       K-K Restaurants, Inc. (“K-K”); Tiffin Avenue Realty Co.,
evidence of similar transactions between uncontrolled             Inc. (“Tiffin”); and Bryan Realty, Inc. (“Bryan”) (collectively
taxpayers. See Lufkin Foundry & Machine Co., 468 F.2d at          “Petitioners”), are members of a commonly owned group of
808; see also Treas. Reg. § 1.482-2(b)(3).                        fourteen corporations (collectively “Group”). During the
                                                                  years 1990 through 1992, George Kentris (“G. Kentris”),
   For this first burden, the Commissioner is not required to     Michael Kentris (“M. Kentris”), and Kenneth Baerwaldt
support the notice of deficiency with proof because courts        (“Baerwaldt”), either individually or with their wives
generally do not examine the underlying motives or policy of      (collectively “Owners”), owned equal shares of the Group.
the Commissioner’s determination. See Pasternak v.
Commissioner, 990 F.2d 893, 898 (6th Cir. 1993). Also,              Of the fourteen Group members, thirteen either own and
when determining whether the Commissioner’s reallocation          operate one or more Taco Bell restaurants (“Restaurant
is reasonable, courts focus on the reasonableness of the result   Corporations”) or own the real estate (“Realty Corporation”)
and not the details of the methodology employed. See              on which another member of the Group operates a Taco Bell
Seagate Tech., Inc. & Consol. Subs. v. Commissioner, 102          restaurant. The following is a chart identifying the thirteen
T.C. 149, 164 (1994); see also Bausch & Lomb, Inc. v.             Restaurant and Realty Corporations:
Commissioner, 92 T.C. 525, 582 (1989).
                                                                    Restaurant                            Realty
  Under the second burden, which only arises after                  Corporations    Location              Corporations
Petitioners have satisfied the first burden, Petitioners “still     K-K             Findlay, OH           Tiffin
have the burden of proving that their own allocation satisfies      K-K             Findlay, OH           Trenton Ave. Realty
the arm’s length standard.”            Inverworld, Inc. v.          Kenco           Lima, OH              Harding Highway Realty
Commissioner, 71 T.C.M. (CCH) 3231, 3237-62 (1996); see             Kenco           Lima, OH              Allentown Road Realty
also Achiro v. Commissioner, 77 T.C. 881, 900 (1981). If            Bowling Green   Bowling Green, OH     Bowling Green
                                                                    GMK             Defiance, OH          unrelated corporation
Petitioners fail to carry this burden, the tax court must           Perrysburg      Perrysburg, OH        Perrysburg
determine a proper allocation based on the record. See              Wapak           Wapakoneta, OH        Apollo Drive Realty
Inverworld, Inc., 71 T.C.M. (CCH) at 3237-62 (citing Eli            Bryan Rest.     Bryan, OH             Bryan
Lilly 7 Co, 856 F.2d at 860).
                                                                    The fourteenth Group member, BKK Management, Inc.
   We conclude that Petitioners’ allocations are not an arm’s-    (“BKK”), neither owns a Restaurant Corporation nor owns a
length charge because Petitioners provide no evidence of an       Realty Corporation. Instead, BKK provides management and
independent transaction between unrelated parties in similar      administrative services to the thirteen Group members and
circumstances. Also, the facts support our conclusion that        bills each Group member for these services. These services
Petitioners were not dealing at arm’s length but were, instead,   are not in dispute and, according to the tax court’s opinion,
allocating their costs based on an ability to pay. Petitioners    include “accounting and administrative services, advertising,
charged Wapak, a Restaurant Corporation, no management            coordination and installation of Taco Bell menus,
fee in 1990, but when its income increased in 1991 and 1992,      renovations, remodeling and repairs, building and equipment
4    Kenco Restaurants, et al.                 Nos. 98-2416/      Nos. 98-2416/                  Kenco Restaurants, et al.     13
     v. Commissioner                         2417/2418/2420       2417/2418/2420                        v. Commissioner

maintenance, insurance coverage, training, inspections, and       Treas. Reg. § 1.482-2(b)(7)(ii)(a).
contracting.” Kenco Restaurants, Inc. v. Commissioner, 76
T.C.M. (CCH) 512, 513 (1998). The services are performed            We conclude that BKK’s performance of services for other
by Owners and BKK’s support staff, and BKK pays their             Group members is an “integral part” of its business activity
salaries. Baerwaldt and M. Kentris provide the operational        and that an arm’s-length charge is equal to “the amount which
management of the restaurants, and G. Kentris, an attorney,       was charged or would have been charged” for same or similar
works half as many hours as the former two and is responsible     services “in independent transactions with or between
for the Group’s administrative and legal needs, which include     unrelated parties under similar circumstances.” Treas. Reg.
payroll, contracts, finances, and legal matters.                  § 1.482-2(b)(3). We reach this conclusion because BKK is a
                                                                  member of a controlled group and renders services as its
   All costs that BKK incurs for providing these services are     principal activity.
allocated to Group members as a “management cost share”
fee. These fees have two categories: payroll related (salaries,      The Group members are members of a “controlled group,”
employment taxes, and health benefits) and incidental (office     as used in Treasury Regulation § 1.482-2(b)(7)(ii), because
supplies, telephone charges, and rent). Approximately 85          each Group member is a “controlled taxpayer.” “Controlled
percent of BKK’s payroll related costs are attributable to        taxpayer” is defined as “any one of two or more
Owners, and approximately 15 percent are attributable to the      organizations, trades, or businesses owned or controlled
support staff.                                                    directly or indirectly by the same interests.” Treas. Reg.
                                                                  § 1.482-1(a)(4). In the instant case, Petitioners are controlled
   Petitioners contend that BKK’s payroll related costs were      taxpayers because it is undisputed that they are commonly
allocated according to the number of hours each Owner spent       owned corporations and are owned equally by Owners. Also,
with each Group member. For an upcoming year, the Owners          BKK renders services to Group members as its principal
projected the hours they would spend with each Group              activity because the parties have stipulated that the primary
member based on the hours they spent the previous year.           purpose of BKK is to provide services to Group members.
Then, they adjusted their projections for upcoming projects       Thus, both the “25 percent test” and the “facts and
and reevaluated them at midyear. However, the Owners did          circumstances test” of Treasury Regulation § 1.482-2(b)(7)(ii)
not maintain time logs or written documents recording their       are satisfied.
actual hours. Petitioners further contend that BKK allocated
its incidental costs to Group members based on their                Now that we have defined an arm’s-length charge, we must
consumption.                                                      next determine whether Petitioners have overcome two
                                                                  burdens of proof. Under the first burden, Petitioners must
  The fees that Group members paid to BKK are reflected in        prove that the Commissioner’s reallocations are wrong,
the following chart. To the right of each fee is the percentage   because the notices of deficiency have a presumption of
that the fee represents of BKK’s total annual fees.               correctness. See Welch v. Helvering, 290 U.S. 111, 115
                                                                  (1933). This presumption is overcome if Petitioners prove
                                                                  that the reallocations contained in the notices of deficiency
                                                                  are arbitrary, capricious, or unreasonable. See Spicer Theatre
                                                                  Inc., 346 F.2d at 706; see also Eli Lilly & Co. 856 F.2d at
                                                                  860. To prove arbitrary, capricious, or unreasonable,
12       Kenco Restaurants, et al.                      Nos. 98-2416/         Nos. 98-2416/                            Kenco Restaurants, et al.             5
         v. Commissioner                              2417/2418/2420          2417/2418/2420                                  v. Commissioner

is “the amount which was charged or would have been                                                        Restaurant Corporations
charged for the same or similar services in independent                                                   1990              1991               1992
transactions with or between unrelated parties under similar                          **
                                                                              Kenco        FEE / % 313,700.00/43.0% 413,000.00/42.3%      389,000.00/33.5%
circumstances considering all relevant facts.” Treas. Reg.
                                                                              K-K**        FEE / %   279,650.00/39%     283,500.00/29%    380,600.00/32.9%
§ 1.482-2(b)(3).
                                                                              GMK          FEE / %     9,100.00/1.0%     21,700.00/2.2%     87,200.00/7.5%
  Of the four situations that the regulations consider an                     Perrysburg FEE / %      29,000.00/4.0%     60,415.00/6.2%     42,700.00/3.7%
“integral part of the business activity,”3 the most applicable                Bowling
to the instant facts is Treasury Regulation 1.482-2(b)(7)(ii).                Green        FEE / %    30,500.00/4.2%     82,000.00/8.4%    112,000.00/9.7%
In this section, “[s]ervices are an integral part of the business             Wapak        FEE / %         0.00/0.0%     29,600.00/3.0%     52,366.00/4.5%
activity of a member of a controlled group where the renderer
renders services to one or more related parties as one of its                 Bryan
                                                                              Rest.        FEE / %         ---------        ---------       6,000.00/0.5%
principal activities.” Treas. Reg. § 1.482-2(b)(7)(ii). Services
are considered “principal activities” if the following two tests4                                             Realty Corporations
are satisfied. First, the renderer’s cost of services
“attributable to the rendition of services for the taxable year                                           1990              1991               1992
to related parties” must exceed “25 percent of the total costs                Tiffin**     FEE / % 28,000.00/3.9%        31,000.00/3.2%     26,000.00/2.2%
or deductions of the renderer for the taxable year [25 percent                Trenton      FEE / % 12,000.00/1.7%        14,500.00/1.5%     16,100.00/1.4%
test].” Treas. Reg. § 1.482-2(b)(7)(ii)(a). Second, the facts                 Allentown FEE / %      2,000.00/0.3%        8,700.00/0.9%     11,100.00/1.0%
and circumstances determine whether the rendition of services
to related parties is one of the principal activities of the                  Harding
                                                                              Highway      FEE / % 18,000.00/2.5%        24,000.00/2.5%     25,000.00/2.2%
renderer (“facts and circumstances test”). See Treas. Reg.
§ 1.482-2(b)(7)(ii)(a). The regulations consider six factors:                 Apollo       FEE / %   3,000.00/0.4%        7,700.00/0.8%      7,200.00/0.6%
                                                                              Bryan**      FEE / %    ---------             ---------        3,000.00/0.3%
  the time devoted to the rendition of the services, the
  relative cost of the services, the regularity with which the                  After an audit, IRS Agent Camper (“Camper”) calculated
  services are rendered, the amount of capital investment,                    the reallocations of BKK’s management    fees to reflect each
  the risk of loss involved, and whether the services are in                  Group member’s yearly gross sales.1 These reallocations
  the nature of supporting services or independent of the                     decreased the share of BKK fees claimed by each Petitioner
  other activities of the renderer.                                           and thus decreased each Petitioner’s deductions.
                                                                              Consequently, the lowered deductions increased each
                                                                              Petitioner’s taxable income and created a disparity between

     3
      Subdivisions (i) through (iv) describe those situations that are             **
considered an “integral part of the business activity.” See Treas. Reg.                Petitioners on appeal.
§§ 1.482-2(b)(7)(i) through (iv).
                                                                                   1
     4                                                                              Camper testified that she used the gross sales method because
      Cost of services includes “all costs or deductions directly or          Petitioners provided no actual time logs or any other information from
indirectly related to the rendition of such services.” Treas. Reg. § 1.482-   which Camper could calculate the actual hours Owners spent with each
2(b)(7)(ii)(b).                                                               Group member.
6        Kenco Restaurants, et al.                  Nos. 98-2416/   Nos. 98-2416/                       Kenco Restaurants, et al.           11
         v. Commissioner                          2417/2418/2420    2417/2418/2420                             v. Commissioner

the taxable income as represented by Petitioners and the              order to prevent evasion of taxes or clearly to reflect the
taxable income as represented by the Commissioner’s                   income of any of such organizations, trades, or
reallocations.    The notices of deficiency that the                  businesses . . . .
Commissioner mailed separately to each Petitioner on June
13, 1995, reflect this disparity. The deficiencies and their        I.R.C. § 4822.
accuracy-related penalties (20 percent) are illustrated in the
following chart:                                                       The “purpose of section 482 is to place a controlled
                                                                    taxpayer on a tax parity with an uncontrolled taxpayer . . . .”
Petitioners   Year     Deficiency    Penalty           Total        Commissioner v. First Security Bank of Utah, 405 U.S. 394,
Kenco         1990     $36,664.00    $7,333.00       $43,997.00
                                                                    400 (1972). If an arrangement between related parties differs
                                                                    from those reached in an uncontrolled, arm’s-length dealing,
Kenco         1991      23,068.00     4,614.00        27,682.00     the Commissioner may reallocate under section 482. See
                                                                    Lufkin Foundry and Machine Co. v. Commissioner, 468 F.2d
K-K           1990      35,056.00     7,011.00        42,067.00     805, 807 n.2 (5th Cir. 1972) (citing Spicer Theatre, 346 F.2d
K-K           1991      18,962.00     3,792.00        22,754.00     at 706). This authority includes reallocating charges among
                                                                    controlled corporations for “marketing, managerial,
K-K           1992      21,304.00     4,261.00        25,566.00     administrative, technical, or other services” that do not
Tiffin        1990       4,772.00       954.00         5,726.00
                                                                    represent an arm’s-length charge. See Treas. Reg. § 1.482-
                                                                    2(b)(1).
Tiffin        1992       4,124.00       825.00         4,949.00
                                                                       Whether the notices of deficiency are arbitrary, capricious,
Bryan         1992         174.00        35.00           209.00     or unreasonable depends, in part, on whether the charges were
TOTAL                 $184,435.00    $36,887.00     $221,323.00     arm’s length. If the charges were equivalent to charges made
                                                                    at arm’s length, then Petitioners have satisfied their burden of
  On August 18, 1995, Petitioners filed separate petitions in       proving that the notices of deficiency are arbitrary, capricious,
the United States Tax Court for a redetermination of the            or unreasonable. The regulations of section 482 govern the
deficiencies and accuracy-related penalties. These petitions        definition of an arm’s-length charge.
were consolidated at trial.
                                                                      If BKK’s services are not an “integral part of the business
  At trial, the Commissioner retained Sharon Moore                  activity,” then an arm’s-length charge is generally equal to the
(“Moore”), a business valuation expert with Alpha Consulting        costs or deductions incurred in rendering such services. See
Alliance, to decide whether BKK’s fee allocations were              Treas. Reg. § 1.482-2(b)(3). However, if BKK’s services are
consistent with an arm’s-length transaction.           Moore        an “integral part of the business activity,” then the costs or
determined that Petitioners’ allocations were not arm’s length      deductions incurred are not an arm’s-length charge. See
and devised her own time-based allocations. To calculate            Treas. Reg. § 1.482-2(b)(7). Rather, an arm’s-length charge
these time-based allocations, Moore used the hours that each
Owner and BKK employee spent in performing services for
each Group member, which Moore obtained through                         2
                                                                          Unless otherwise indicated, all section references are to the Internal
interviews with Owners and BKK employees, rather than               Revenue Code and its Regulations that are in effect for the taxable years
                                                                    in issue.
10   Kenco Restaurants, et al.                 Nos. 98-2416/     Nos. 98-2416/                 Kenco Restaurants, et al.     7
     v. Commissioner                         2417/2418/2420      2417/2418/2420                       v. Commissioner

deficiency are arbitrary, capricious, or unreasonable. Because   adopting Petitioners’ method of using only Owner hours.
deficiency notices have a presumption of correctness,            Moore included the projected hours of a district manager, a
Petitioners have the burden of overcoming this presumption       maintenance man, and BKK’s in-house accountant
by proving that their initial allocations were arm’s length.     (“Borsani”). In contrast to Petitioners’ allocations, Moore
                                                                 weighed Owner and employee hours equally because Moore
   Petitioners contend that the Commissioner’s reallocation      found that both Owners and employees performed similar
method is arbitrary, capricious, or unreasonable for the         operational tasks. Moore then converted the total hours
following three reasons.          First, the Commissioner’s      allocated to each Group member into a corresponding fee
methodology ignores the special situations that justified        allocation and concluded that her time-based allocations were
Petitioners’ initial allocations. Second, Petitioners contend    more consistent with an arm’s-length charge than were
that their fee allocation is reasonable and arm’s length         Petitioners’ allocations.
because it represents the actual time spent on managing and
operating each Group member. Petitioners further argue that         However, Moore’s allocations pertained only to the six
these records were in fact created and monitored even though     Restaurant Corporations. Moore neither addressed any fees
they were inadvertently destroyed. Third, Moore, the             attributable to the Realty Corporations nor allocated any fees
Commissioner’s expert, conceded that Petitioners’ method of      to Bryan Restaurant, Inc., which was created in 1992.
allocating time was reasonable because Moore’s method is
identical and differs only as to hours.                             At trial, Petitioners disputed Moore’s time-based
                                                                 allocations because Moore never considered special
   The Commissioner contends that Petitioners have failed to     circumstances that varied the time that Owners dedicated to
show that the reallocations contained in the notice of           particular Group members. Specifically, these special events
deficiency are arbitrary, capricious, or unreasonable. In the    include a fire that demolished a Kenco restaurant in 1990, a
alternative, the Commissioner contends that assuming we find     scrape and rebuild of a K-K restaurant in 1990, a unique
the notices of deficiency arbitrary, capricious, or              employment problem in 1990 (i.e., civil rights commission
unreasonable, then Moore’s time-based allocations represent      case filed by former employee), a worker’s compensation
an arm’s-length charge. For this alternative contention,         claim in 1990, additions and remodeling of a K-K restaurant
Commissioner asserts that Moore’s allocations more properly      in 1991, land acquisitions and zoning litigation, dramatic
reflect value added to each Group member.                        decreases in sales caused by rumors of intentionally tainted
                                                                 food in 1992, and the development and opening of the new
  Section 482 of the Internal Revenue Code and its               Bryan restaurant in 1992.
regulations govern the instant case:
                                                                   Petitioners also dispute Moore’s time-based allocations
  In any case of two or more organizations, trades, or           because Moore included hours of modestly compensated,
  businesses . . . owned or controlled directly or indirectly    nonowner employees. Additionally, Petitioners dispute
  by the same interests, the Secretary may distribute,           Moore’s treatment of Owner’s hours as equal to maintenance
  apportion, or allocate gross income, deductions, credits,      workers’ hours. Moreover, Petitioners dispute Moore’s
  or allowances between or among such organizations,             inclusion of 2,000 hours for Borsani in 1992 because Borsani
  trades, or businesses, if he determines that such              worked at BKK for only one month in 1992.
  distribution, apportionment, or allocation is necessary in
8    Kenco Restaurants, et al.                 Nos. 98-2416/      Nos. 98-2416/                  Kenco Restaurants, et al.      9
     v. Commissioner                         2417/2418/2420       2417/2418/2420                        v. Commissioner

  The tax court ruled in favor of the Commissioner and found      that used in the notice of deficiency. This reliance does not
that Petitioners failed to prove that the reallocations in the    necessarily place the burden on the Commissioner or render
notice of deficiency, based upon gross sales, were arbitrary,     the notice of deficiency arbitrary, capricious, or unreasonable.
capricious, or unreasonable. The tax court also sustained the     See Altama Delta Corp. v. Commissioner, 104 T.C. 424, 458
Commissioner’s imposition of accuracy-related penalties.          (1995) (citing Sundstrand Corp. v. Commissioner, 96 T.C.
                                                                  226, 354-355 (1991)).
                              II.
                                                                    However, if the Commissioner abandons the notice of
   We review factual findings of the tax court for clear error    deficiency, then the notice of deficiency is no longer
and legal questions de novo. See Hoover v. Commissioner,          presumed correct, and all that remains is for Petitioners to
102 F.3d 842, 844 (6th Cir. 1996) (citing Conti v.                show that the transaction was conducted at arm’s length. See
Commissioner, 39 F.3d 658, 662 (6th Cir. 1994)). We review        DHL Corp. v. Commissioner, 76 T.C.M. (CCH) 1122, 1144
mixed questions of law and fact under the “clearly erroneous”     (1998).
standard. See Eli Lilly & Co. v. Commissioner, 856 F.2d 855,
860-61 (7th Cir. 1988) (citing Standard Office Bldg. Corp. v.      In the instant case, the tax court found that the
United States, 819 F.2d 1371, 1374 (7th Cir. 1987)). Whether      Commissioner had not abandoned the notices of deficiency:
the Commissioner abused or exceeded his discretion in
determining deficiencies against a taxpayer is a question of        “Although the Moore allocation differs from the amounts
fact. See Spicer Theatre, Inc. v. Commissioner, 346 F.2d 704,       allowed by respondent in the notices of deficiency,
706 (6th Cir. 1965); see also American Terrazzo Strip Co.,          respondent is explicit in stating that he has not
Inc. v. Commissioner, 56 T.C. 961, 971 (1971).                      abandoned the notice and, we believe, relies on the
                                                                    Moore allocation only to prove a reasonable allocation on
  The first issue we address is whether the Commissioner            the contingency that petitioners succeed in showing the
abandoned the notice of deficiency. Petitioners contend that        respondent’s allocation to be arbitrary, capricious, or
the Commissioner abandoned the allocations contained in the         unreasonable.”
notice of deficiency at trial and instead relied upon Moore’s
reallocations.     Also, Petitioners contend that the             Kenco Restaurants, Inc. v. Commissioner, 76 T.C.M. (CCH)
Commissioner has to establish the reasonableness of his           512, 517 (1998).
adjustments because the burden of proof shifted when he
abandoned the original allocations.                                 Upon our review of the record, we agree with the tax court
                                                                  and find that the Commissioner did not abandon the notices
   The Commissioner, however, contends that he never              of deficiency. The record does not support that either the
abandoned the notice of deficiency and that the purpose of        Commissioner or Moore rejected Camper’s method in favor
Moore’s testimony was merely to provide a reasonable              of the time-based method. Also, as shown below in the
allocation in the event Petitioners were successful in proving    second issue, the Commissioner had no reason to establish an
that the allocations contained in the notice of deficiency were   arm’s-length charge other than as a contingency argument in
arbitrary, capricious, or unreasonable.                           case Petitioners overcame the initial presumption.
   Under current law, the Commissioner may rely on                  The second issue we address is whether Petitioners have
alternative theories supported by a different methodology than    shown that the reallocations contained in the notice of
