                         T.C. Memo. 2005-243



                       UNITED STATES TAX COURT



            CHICKIE’S AND PETE’S, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6354-04.               Filed October 17, 2005.



     Harry C. Citrino, Jr., for petitioner.

     Gerald A. Thorpe, for respondent.



             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
                               - 2 -

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 (U.S. Patent

and Trademark office).2   On or about September 1, 1999, peti-

tioner 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



     1
      Respondent concedes that petitioner may deduct $441,210 of
the $902,476 payment in question.
     2
      The application to register the name “Chickie’s and Pete’s”
was submitted to the U.S. Patent and Trademark office on Apr. 17,
1998.
                                - 3 -

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,
     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 devel-
     oped, 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 provi-
     sions 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 * * * Veter-
     ans 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
                          - 4 -

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.
                          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
                                 - 5 -

                                         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 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 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

     3
      Schedule 2(a)(ii) was not attached to the Ogden license
agreement that is part of the record in this case.
                                - 6 -

                                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 produc-
     tion, 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.

     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 manage-

ment 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 good-
     will 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 Agree-
                          - 7 -

ment (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 provi-
sions 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 con-
                          tinuing fee (“Royalty”) peri-
                          odically each year Twenty-two
                          and one-half percent (22.5%)
                          of the Gross Sales for the
                          yearly period September 1st
                          through August 31st each year.

                          (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
                                   - 8 -

                                           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 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


     4
      Schedule 2(a)(ii) was not attached to petitioner’s license
agreement that is part of the record in this case.
                                - 9 -

                                unit or products served. In order
                                to assure that Licensee operates in
                                strict accordance with such stan-
                                dards, 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 Li-
     censee and/or its employees and staff on food produc-
     tion, 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, 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
                               - 10 -

$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 peti-

tioner.    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 exami-

nation 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 require-

ments of section 7491(a)(2).     On that record, we conclude that

petitioner’s burden of proof, see Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (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.


     5
      All section references are to the Internal Revenue Code in
effect for the year at issue. All Rule references are to the Tax
Court Rules of Practice and Procedure.
                              - 11 -

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (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 respon-

dent’s position that petitioner has failed to establish that it

is entitled to a deduction in excess of the amount that respon-

dent concedes.   In support of that position, respondent asserts:

     Mr. Ciarrocchi testified that he believed that peti-
     tioner 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 agree-
     ment 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 limita-
     tions. 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 to the license agreement.


     6
      Respondent states on brief:

     Respondent concedes that the Ogden license agreement
     was negotiated at arm’s length and, thus, is extremely
     probative evidence of the fair market value of the
     rights conveyed to petitioner under * * *
     [petitioner’s] license agreement. Consequently,
     respondent concedes that petitioner is entitled to
     deduct a royalty fee of $441,210, which is equal to 11%
     of its “gross sales” as that term is defined in * * *
     [petitioner’s] license agreement. [Fn. ref. omitted.]
                             - 12 -

        *       *       *       *       *       *       *

          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 deduct-
     ible compensation for services rendered. While I.R.C.
     § 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 peti-
     tioner’s officer and employee. 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, deduct-
     ible under § 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 tradi-
     tional 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 reason-
     able.

          It is well established that for a payment to be
     deductible, the payer must have intended the payment to
                             - 13 -

     be compensation 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 reason-
     able, arm’s-length license agreement with Ogden Enter-
     tainment prior into [sic] his entering into a fair and
     reasonable license agreement with the taxpayer [peti-
     tioner]. 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.

In further support of petitioner’s position, petitioner

asserts:

     Ogden was permitted to use the name “Chickie’s and Pete’s”
     and the “Crabfries®” 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 tech-
     niques. 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 vari-
     ety 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 addi-

tion to the name “Chickie’s and Pete’s”, only the “Crabfries®”

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
                                - 14 -

Stadium concessions.7     In fact, Mr. Ciarrocchi’s testimony estab-

lishes 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 sta-
     dium of anything that was sold with the Chickie’s and
     Pete’s name * * *.

     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 peti-

tioner’s license agreement, instead of 11 percent of gross sales,

which was the fee that 4010, Inc., was to receive under Ogden’s




     7
      See supra note 3.
                              - 15 -

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 (1930); sec. 1.162-7(a),

Income Tax Regs.   On the record before us, we find that peti-

tioner has failed to carry its burden of showing that any portion

of the $902,476 payment that it made to Mr. Ciarrocchi in excess

of the amount that respondent concedes is deductible as a royalty


     8
      Pursuant to Ogden’s license agreement, Ogden also agreed to
make at the inception of that agreement a nonrefundable payment
to 4010, Inc., of $10,000.
     9
      In determining whether compensation is reasonable, we have
applied the so-called multifactor test, see, e.g., Estate of
Wallace v. Commissioner, 95 T.C. 525 (1990), affd. 965 F.2d 1038
(11th Cir. 1992), viewed through the lens of an independent
investor, where a case is appealable to a U.S. Court of Appeals
which has neither adopted nor rejected the so-called independent
investor test established by the U.S. Court of Appeals for the
Seventh Circuit in Exacto Spring Corp. v. Commissioner, 196 F.3d
833 (7th Cir. 1999), revg. Heitz v. Commissioner, T.C. Memo.
1998-220. See, e.g., Haffner’s Serv. Stations, Inc. v.
Commissioner, T.C. Memo. 2002-38, affd. 326 F.3d 1 (1st Cir.
2003). The instant case is appealable to the U.S. Court of
Appeals for the Third Circuit. That Court of Appeals has not
adopted the so-called independent investor test but has endorsed
the traditional multifactor test. See B.B. Rider Corp. v.
Commissioner, 725 F.2d 945 (3d Cir. 1984), revg. and remanding on
other grounds T.C. Memo. 1982-98.
                                    - 16 -

under section 162(a)(3) constitutes compensation for services

rendered that is deductible under section 162(a)(1).

      Based upon our examination of the entire record before us,

we find that petitioner has failed to carry its burden of estab-

lishing 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.




[Reporter’s Note: This report was modified by Order dated Nov. 7, 2005.]
