                    T.C. Memo. 1998-252



                  UNITED STATES TAX COURT



RJR NABISCO INC. (FORMERLY R.J. REYNOLDS INDUSTRIES, INC.)
        AND CONSOLIDATED SUBSIDIARIES, Petitioner v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



 Docket No. 3796-95.                 Filed July 8, 1998.


      P is the common parent of an affiliated group of
 corporations making a consolidated return of income.
 M1, a member of the affiliated group, claimed a
 deduction pursuant to sec. 162, I.R.C., for graphic
 design expenditures relating to cigarette package
 designs. M2, another member of the affiliated group,
 reported a portion of an international arbitration
 award that it received as an amount realized on the
 sale or other disposition of property. R determined a
 deficiency in P's consolidated income tax liability,
 disallowing the deduction as a sec. 162, I.R.C.,
 expense and recharacterizing the graphic design
 expenditures as capital expenditures. R further
 treated the disputed portion of the arbitration award
 as ordinary income. Held: Graphic design expenditures
 for cigarette packages are advertising expenses,
 deductible under sec. 162, I.R.C. Held, further, the
 disputed portion of the arbitration award is an amount
 realized on the sale or other disposition of property.
                               - 2 -



     Wayne S. Kaplan, William Albert Schmalzl, Thomas Kittle-

Kamp, Clisson S. Rexford, and Stephen D. Katzman, for petitioner.

     Kim A. Palmerino and Gary Walker, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     HALPERN, Judge:   Petitioner is the common parent corporation

of an affiliated group of corporations making a consolidated

return of income (the affiliated group).   By notice of deficiency

dated December 15, 1994 (the notice), respondent determined a

deficiency in Federal income tax for the affiliated group for its

1982 taxable (calendar) year in the amount of $9,856,982.76 along

with an increased rate of interest under section 6621(c).   The

issues for decision are (1) the deductibility of graphic design

expenditures made in connection with certain cigarette products

and (2) the character of a portion of a payment received as the

result of an arbitration proceeding arising from the

expropriation of certain property by the Government of Kuwait.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.
                              - 3 -


                            CONTENTS

FINDINGS OF FACT............................................... 4
  I. Introduction............................................. 4
 II. Graphic Design Issue..................................... 4
      A. R.J. Reynolds Tobacco Co.; Nature of the Dispute..... 4
      B. Graphic Design; Package Design....................... 5
      C. Reynolds' Cigarette Products......................... 5
      D. Reynolds' Marketing Activities....................... 6
      E. Graphic Designs...................................... 8
      F. Advertising.......................................... 8
      G. Longevity of Graphic Designs and Advertising
          Campaigns............................................ 9
      H. Litigated Expenses...................................10
III. Expropriation Issue......................................10
      A. American Independent Oil Co.; Nature of the Dispute..10
      B. Events Leading to the Expropriation................. 11
      C. The Expropriation and the Arbitration............... 13
          1. The Expropriation and the Agreement for
              Arbitration..................................... 13
          2. Conduct of the Arbitration...................... 14
          3. Questions Presented to the Tribunal............. 15
          4. Aminoil’s Claims With Respect to Expropriated
              Assets.......................................... 15
          5. Rate of Interest; Inflation..................... 17
          6. Final Award..................................... 17
          7. Validity of the Expropriation................... 19
          8. The Question of Indemnification................. 21
      D. Petitioner’s Tax Treatment of the Award............. 25
OPINION....................................................... 27
  I. Graphic Design Issue.................................... 27
      A. Issue............................................... 27
      B. Arguments of the Parties............................ 27
      C. Tax Rules Governing Advertising Expenditures........ 29
          1. Introduction.................................... 29
          2. Deductible Business Expenses.................... 31
          3. Ordinary Business Advertising................... 32
      D. Advertising Campaign Expenditures................... 39
      E. Conclusion.......................................... 44
 II. Expropriation Issue..................................... 46
      A. Description of the Issue............................ 46
      B. Arguments of the Parties............................ 47
      C. Discussion.......................................... 48
          1. Introduction.................................... 48
          2. Authority To Interpret the Award................ 49
          3. The Award Is Ambiguous.......................... 49
          4. Extrinsic Evidence.............................. 53
          5. Expert Testimony of Charles N. Brower........... 53
          6. Respondent’s Position........................... 58
                                  - 4 -


             7. Conclusion...................................... 59
        D.   Income Tax Consequences............................. 60

                            FINDINGS OF FACT

I.    Introduction

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

The stipulations of facts filed by the parties, with attached

exhibits, are incorporated herein by this reference.

       Petitioner, a Delaware corporation, maintained its principal

office in New York, New York, at the time the petition was filed.

II.    Graphic Design Issue

       A.    R.J. Reynolds Tobacco Co.; Nature of the Dispute

       During 1982, R.J. Reynolds Tobacco Co. (Reynolds), a New

Jersey corporation, was a member of the affiliated group.       During

that year, Reynolds was engaged in the business of manufacturing

and marketing tobacco products.      Reynolds had $3.6 billion of

sales in 1982 and, in reporting its income for Federal income tax

purposes, claimed a deduction for graphic design and package

design expenditures in the amount of $2,196,441 (the disallowed

deduction).      Respondent disallowed that deduction on the grounds

that petitioner had failed to establish that the disallowed

deduction represented an ordinary and necessary business expense

or was otherwise deductible.      (The principal dispute between the

parties is whether the disallowed deduction is not a section 162

expense because it is a capital expenditure.)
                                - 5 -


     B.    Graphic Design; Package Design

     A “graphic design” (graphic design) is a combination of

verbal information, styles of print, pictures or drawings,

shapes, patterns, colors, spacing, and the like that make up an

overall visual display.    The term “package design” (package

design) refers to the design of the physical construction of a

package.

     C.    Reynolds' Cigarette Products

     Among the tobacco products manufactured and marketed by

Reynolds are cigarettes in the following product lines: Camel,

Century, More, Now, Salem, Sterling, Vantage, and Winston.      A

product line is distinguished by a brand name (e.g., Camel) and

may contain different cigarette products (e.g., Camels, Camel

Filters, and Camel Lights).    Cigarettes are packaged in either

soft-packs or crush-proof boxes.

     Different cigarette products have different attributes, and

Reynolds can combine those attributes to make different products.

Among the available attributes are: (1) name, (2) tar and

nicotine content (full flavor, light, or ultra light), (3) length

in millimeters (e.g., 70, 85, or 100 millimeters), (4) flavor

(e.g., regular, menthol, or mint), (5) tobacco blends (flue-

cured, burley, and oriental tobaccos), (6) package (soft-pack or

crush-proof box), (7) circumference (regular, wide, slender,

slim, or super slim), (8) filter or nonfilter, (9) quantity in a
                               - 6 -


package, (10) filter-tip type (standard, charcoal, or hard

plastic), and (11) graphic designs.

     In part, imagery sells cigarettes.    The imagery that sells

cigarettes includes imagery that projects the experience of using

the product (e.g., smooth or light) and imagery that projects

characteristics attractive to the targeted consumer group (e.g.,

masculine or sociable).   Such imagery significantly influences

consumers' decisions about which brand to smoke.   Other products

for which imagery is a substantial factor in consumers'

purchasing decisions include perfume, automobiles, and alcoholic

beverages.   Such products are often described as “image”

products.

     The cigarette package is particularly important in selling

cigarettes because (1) some cigarette products differ little or

not at all in their physical attributes and are distinguished

primarily or entirely by the imagery associated with them and

(2) the smoker and those around the smoker see the package

numerous times a day.

     D.   Reynolds' Marketing Activities

     Reynolds regularly and continuously engages in marketing

activities with respect to its cigarette products.   Reynolds

proceeds in three broad steps to accomplish its marketing

activities: (1) determining product position, (2) developing a
                                - 7 -


marketing strategy, and (3) deciding on the tactics to implement

the marketing strategy.

     For a cigarette product, determining product position is the

most important step.    It involves determining the overall concept

of what the product is intended to offer and the segment of

smokers to whom the product is intended to appeal.

     After determining a product's intended position, Reynolds

develops a marketing strategy to achieve that position.    The

basic elements of a marketing strategy for a cigarette product

include: (1) choosing the product’s name, (2) determining the

desired physical characteristics of the product (e.g., the

tobacco blend and whether the cigarette will have a filter tip),

(3) developing graphic and package designs, (4) determining an

appropriate price, (5) developing an advertising campaign, and

(6) developing appropriate promotions.

     Finally, Reynolds employs specific tactics to implement the

marketing strategy.    Those tactics include: (1) developing

executions for the advertising campaign (i.e., the specific,

individual advertisements that implement the theme or themes of

the campaign), (2) determining in which media to advertise, and

(3) selecting product promotions (e.g., “in-store” promotions,

discounts and coupons, direct mail promotions, and event

marketing).
                              - 8 -


     With respect to each cigarette product, all of the

activities constituting Reynolds’ marketing strategy and

implementation tactics are part of a coordinated effort to convey

the intended image and achieve the intended positioning for the

product.

     E.    Graphic Designs

     Graphic designs are developed for the following components

of a cigarette product: cartons, packages, flags (messages

temporarily applied to cartons or packages, e.g., “New!”),

tipping (the printed wrap around the filter), cigarette papers

(which hold the tobacco), foils (the inner lining between the

cigarettes and soft-pack or box), and, for soft packs, a closure

seal (across the top of the package).   The graphic designs for a

product serve, among other things, to identify the product,

convey information, and attract attention at the point of sale

when the retailer displays the pack.

     F.    Advertising

     The advertising for a product serves to convey information,

project the image chosen for the positioning of the product, and

attract consumer attention.

     The advertising strategy for a product entails the

development of the following components:

     (1) Creation of the advertising “campaign”, which, along
     with other marketing efforts, projects the image or message
                               - 9 -


     chosen to achieve the intended positioning through
     consistent visual imagery;

     (2) Creation of advertising “executions”, which are the
     specific individual advertisements that implement the theme
     or themes of the campaign; and

     (3) Determination of “media placement”, which involves the
     selection of the appropriate media forums for placement of
     the individual advertising executions, such as magazines,
     newspapers, billboards, and in-store (“point of sale”)
     displays.

During the period a campaign is running, a company customarily

uses a number of executions in order to maintain consumer

interest in the campaign.   A company also may alter media

placements of the executions while a campaign runs.

     G.   Longevity of Graphic Designs and Advertising Campaigns

     At the time graphic designs or advertising campaigns are

introduced, no one can determine how long the graphic designs,

advertising campaigns, or elements of such designs or campaigns

will be used, including whether or not they will be used for more

or less than a single year.   Numerous advertising campaigns,

advertising campaign slogans, and advertising characters (e.g.,

the Maytag repairman) have lasted for more than a single year.

Companies may use identical advertising executions for more than

a single year.   For example, television commercials for Budweiser

beer featuring Clydesdale horses and Norelco shavers featuring

Santa Claus run annually during the yearend holiday season and

three commercials from the “Dr. Mom” campaign for Robitussin
                                   - 10 -


cough syrup aired for between 4 and 8 years.       Portions of one

advertising execution may be used in later executions of the same

or different campaigns.      For example, E.F. Hutton ran

advertisements in 1979, 1980, and 1982, that all contained the

line:       “When E.F. Hutton talks, people listen.”

       H.     Litigated Expenses

        The parties have identified a portion of the disallowed

deduction as the “litigated expenses” (litigated expenses).         The

parties wish us to decide the deductibility of the litigated

expenses.       They then will use our decision as a basis to settle

their disagreement with respect to the remaining disallowed

deductions.       The litigated expenses total $1,804,029 and relate

to the product lines described in supra at section II.C.

III.     Expropriation Issue

        A.    American Independent Oil Co.; Nature of the Dispute

        During 1982, American Independent Oil Co. (Aminoil), a

Delaware corporation, was a member of the affiliated group.

Aminoil had been in the business of exploring for, producing,

refining, and selling crude oil and other natural resources

outside of the United States.       From 1948 until 1977, Aminoil

enjoyed a concession to explore for and exploit oil, gas, and

other natural resources in an area on the frontier of Kuwait.        In
                              - 11 -


1977, the Government of Kuwait1 terminated the concession and

expropriated certain property of Aminoil.   Aminoil disputed the

termination and expropriation, and that dispute, along with

certain of Kuwait’s claims, was submitted to arbitration.    The

arbitrators reached a decision that resolved Aminoil’s and

Kuwait’s competing claims, and the arbitrators awarded Aminoil

$179,750,764.   In arriving at that sum, the arbitrators included

$55,147,935 as a “level of inflation” adjustment.   (We must

determine whether the so-called “level of inflation” adjustment

is an amount realized on the sale or other disposition of any of

the property expropriated by Kuwait.)

     B.   Events Leading to the Expropriation

     By an agreement entered into on June 28, 1948, Kuwait

granted Aminoil the concession to explore for and exploit crude

oil, natural gas, and other natural resources in the Kuwaiti

section of an area on the frontier between Kuwait and Saudi

Arabia then known as the “Neutral Zone” and later known as the

“Divided Zone”.   (Hereafter, the term “concession agreement”

refers to the agreement entered into on June 28, 1948 (including

its subsequent amendments), the term “concession” refers to the

concession obtained by Aminoil pursuant to the concession


1
     Hereafter, we will use the term “Kuwait” to refer to the
Government of Kuwait except where the context indicates that we
are referring to the geographical area comprising the country of
Kuwait.
                              - 12 -


agreement, and the term “Neutral Zone” refers both to the Neutral

Zone and the Divided Zone.)

     The concession agreement authorized Aminoil, at its own

expense, to construct and operate power stations, refineries,

pipelines, and other facilities necessary to the conduct of its

activities in the Neutral Zone and gave Aminoil exclusive

ownership of all petroleum and natural gas that it extracted.    In

consideration of its rights under the concession agreement,

Aminoil agreed to make a lump-sum payment to Kuwait and to pay

annual royalties.

     The concession agreement was to remain in effect until

June 28, 2008, unless earlier terminated for cause.   Upon

termination, all of Aminoil’s real and personal property in

Kuwait and the Neutral Zone would pass to Kuwait free of charge.

     On various occasions, Aminoil’s financial obligations to

Kuwait under the concession agreement were renegotiated (to

include the imposition of an obligation to pay Kuwait income

taxes).   In late 1975, Kuwait announced that it intended to apply

to Aminoil a 1974 Organization of Petroleum Exporting Countries

(OPEC) resolution known as the “Abu Dhabi Formula” (Abu Dhabi

Formula).   The Abu Dhabi Formula would have substantially raised

Aminoil’s royalty and tax obligations to Kuwait.   Aminoil

objected to the imposition of the Abu Dhabi Formula, and

negotiations between Aminoil and Kuwait followed, which lasted

until some time in 1977.
                                - 13 -


     C.    The Expropriation and the Arbitration

            1.   The Expropriation and the Agreement for Arbitration

     On September 19, 1977, Kuwait terminated the concession and

expropriated all of Aminoil’s properties and assets in Kuwait and

the Neutral Zone (the expropriation date and the expropriation,

respectively).    Aminoil protested the expropriation.   The

expropriation was also of concern to the Government of the United

States, and, on October 27, 1977, at a meeting in Kuwait, the

Secretary of the Treasury of the United States, W. Michael

Blumenthal, discussed the expropriation with Kuwait’s Minister of

Finance.    Secretary Blumenthal expressed the hope that Aminoil

would receive full and fair compensation from Kuwait.

Subsequently, representatives of the U.S. Department of State

encouraged Kuwait to agree to an arbitration proceeding.       On

July 23, 1979, Aminoil and Kuwait entered into an agreement (the

arbitration agreement) providing for an arbitration (the

arbitration) of various differences and disagreements relating to

the concession agreement and the expropriation.2    The arbitration

agreement established a tribunal of three members to hear and

decide the dispute (the tribunal and the dispute, respectively).

The three members of the tribunal were (1) Sir Gerald G.

Fitzmaurice, Q.C., from the United Kingdom, appointed by Aminoil,


2
     Hereafter, we shall use the term “parties” to refer to
Aminoil and Kuwait, as parties to the arbitration agreement,
except where the context indicates that we are referring to
petitioner and respondent as parties to this proceeding.
                                - 14 -


(2) Professor Hamed Sultan, from Egypt, appointed by Kuwait, and

(3) Professor Paul Reuter, president of the tribunal, professor

of law at the University of Paris, appointed by the president of

the International Court of Justice.      All three members of the

tribunal are now deceased.     The arbitration agreement reflects

the parties’ recognition that it would be impracticable to

restore them to their respective positions prior to the

expropriation.    Article III of the arbitration agreement empowers

the tribunal to decide:

     (1)   The amount of compensation, if any, payable by Kuwait
           to Aminoil in respect of the assets acquired by Kuwait
           pursuant to the expropriation;

     (2)   The amount of damages, if any, payable by Kuwait to
           Aminoil in respect of the termination of the concession
           agreement;

     (3)   The amount payable by one party to the other under the
           concession agreement in respect of royalties, taxes, or
           other obligations; and

     (4)   The amount of interest, if any, payable by either party
           to the other, the rate of such interest, and the date
           from which such interest shall be payable.

The arbitration agreement provides that the seat of the

arbitration shall be Paris.

           2.    Conduct of the Arbitration

     The arbitration was conducted similarly to a judicial

proceeding.     The tribunal established procedural rules; the

parties submitted combined pleadings and briefs (called

“Memorials”, “Counter-Memorials”, and “Replies”); the tribunal
                                - 15 -


received documentary evidence and expert reports, and the

tribunal heard witnesses and received oral argument.      The

tribunal’s procedures provided for hearings, to be conducted in

two stages, with the second devoted to “quantum”.      Eventually,

however, the tribunal found the quantum stage to be unnecessary,

and it never occurred.

          3.     Questions Presented to the Tribunal

     Among the questions presented to the tribunal were the

following:     (1) Whether the expropriation constituted a breach of

the concession agreement by Kuwait and, therefore, was an

unlawful taking under public international law, (2) whether

Aminoil’s reparation should be measured by the public

international law standard for a lawful expropriation or by the

higher public international law standard for an unlawful

expropriation, and (3) whether Aminoil’s reparation should

include compensation for its concession as measured by the

profits Aminoil lost as a result of the premature termination of

the concession agreement.    Other questions presented to the

tribunal included the question of whether any interest was due

either party, as provided for by the arbitration agreement, and

questions relating to Kuwait’s counterclaims against Aminoil for

royalties, taxes, and other asserted liabilities.

     The question of whether the expropriation was lawful or

unlawful was important for Aminoil because it believed that,
                              - 16 -


under public international law, if the expropriation were

unlawful, it would be entitled to be recompensed for any increase

in the value of its assets between the expropriation date and the

date of any award.

          4.   Aminoil’s Claims With Respect to Expropriated
               Assets

     As recompense for its assets other than the concession,

Aminoil sought to recover the amounts of money and other current

assets taken and, with respect to its fixed assets, their

depreciated replacement value.   Aminoil claimed that Kuwait had

expropriated money and other current assets with a total value of

$30,356,000.   Aminoil claimed $2,587,136,000 of lost profits,

calculated on a 1980 present value basis.   Recognizing that the

concession agreement would have required it to transfer its fixed

assets to Kuwait free of charge upon the concession’s natural

termination on June 28, 2008, Aminoil sought no payment for its

fixed assets in the event the tribunal awarded it compensation

for the concession measured by profits lost for the entire period

through the natural termination date.   Aminoil sought recovery

for its fixed assets only if the tribunal measured the lost

profits attributable to the concession through some date prior to

2008, in which case Aminoil demanded to be paid for the fixed

assets’ depreciated replacement value as of that sooner date.

Aminoil presented the tribunal with an expert valuation report

finding that the depreciated replacement value of the fixed

assets on the expropriation date was $185,305,000.
                                - 17 -


     With respect to Aminoil’s claims for recompense for its

assets, Kuwait argued that the only proper measure of

compensation for any of Aminoil’s assets was book value.

Kuwait’s position reflected the stated policy of OPEC that

compensation to Western oil companies should be based exclusively

on book value and that any other basis for compensation,

including, in particular, any measure of lost profits, should be

refused.    The parties submitted a joint report to the tribunal

(the joint report) that showed unagreed amounts for book values

as follows:

                            Aminoil’s            Kuwait’s
                            Position             Position
        Assets            (in thousands)       (in thousands)
     Fixed assets            $10,619              $8,610
     Other assets             31,857              28,075
        Total                $42,476             $36,685

            5.   Rate of Interest; Inflation

     With respect to the interest that was to be determined by

the tribunal, only Aminoil suggested any specific rates of

interest.     Kuwait proposed only that the interest rate be an

“appropriate rate”.     Aminoil suggested the following rates of

interest:

                       1973            7.90%
                       1974            8.43%
                       1975            7.21%
                       1976            5.23%
                       1977            7.39%
                       1978           11.16%
                       1979           13.17%
                               - 18 -



     Other than their respective requests for interest, neither

party asked the tribunal to award it any compensation for the

delayed payment of its claimed damages.   Neither party asked the

tribunal to make a separate award based upon “inflation”.

          6.   Final Award

     The arbitration agreement provided for a “final award” (the

award).   The tribunal issued a document constituting the award on

March 24, 1982.    The award consists of eight sections and is 139

pages in length.   The eighth section is entitled “OPERATIVE

SECTION (DISPOSITIF)” (operative section), and provides as

follow:

     For these reasons,

     THE TRIBUNAL, unanimously, having regard to all of the
     above mentioned considerations,

     AWARDS to Aminoil,

     THE SUM OF ONE HUNDRED AND SEVENTY NINE MILLION, SEVEN
     HUNDRED AND FIFTY THOUSAND, SEVEN HUNDRED AND SIXTY
     FOUR UNITED STATES DOLLARS ($179,750,764) calculated on
     the basis of being payable on 1 July, 1982.

     Kuwait honored the amount of the award and paid $179,750,764

to Aminoil on July 1, 1982 (the $179 million payment).

     The body of the award preceding the operative section sets

forth the reasoning of the tribunal.    The first section reviews

the procedural setting of the arbitration and summarizes the

claims of the parties.    The second section sets forth the facts

of the case.   The third section determines the applicable law,
                               - 19 -


which, as to the substantive issues in dispute, the tribunal

concludes to be established public international law (which the

tribunal concludes is part of the law of Kuwait).   The fourth

section analyzes certain of the contractual obligations of the

parties’ and concludes that (1) in light of negotiations between

the parties preceding the expropriation, some amount is owing to

Kuwait from Aminoil on account of past profits received by

Aminoil in excess “of what would have constituted a reasonable

rate of return” to Aminoil and (2) within the framework of a

general settlement of the consequences of the expropriation, the

tribunal has jurisdiction to determine such amount due to Kuwait.

The fifth section addresses the validity (lawfulness) of the

expropriation and is described infra at section II.C.7.   The

sixth section deals with certain miscellaneous counterclaims by

Kuwait against Aminoil.   The seventh section is captioned “The

Question of Indemnification” and sets forth the tribunal’s

resolution of Kuwait’s claims against Aminoil and Aminoil’s

claims against Kuwait and is described in infra at section

III.C.8.

           7.   Validity of the Expropriation

     In the fifth section of the award (section five), the

tribunal begins its discussion of the validity of the

expropriation by recognizing that the question of validity “lies

at the core of the present litigation.”   The tribunal did not

have difficulty in disposing of the parties’ various arguments
                                - 20 -


except for Aminoil’s contention relying on the “stabilization

clauses” of the concession agreement (the stabilization clauses).

Introducing the tribunal’s analysis of the stabilization clauses,

section five states:

     Nevertheless, Aminoil’s concessionary contract
     contained specific provisions in the light of which it
     may be queried whether the nationalisation was in truth
     lawful.

The stabilization clauses are set forth in section five as
follows:

     The period of this Agreement shall be sixty (60) years
     from the date of signature.

                       *    *     *       *     *

     The Sheikh shall not by general or special legislation
     or by administrative measures or by any other act
     whatever annul this Agreement except as provided in
     Article 11. No alteration shall be made in the terms
     of this agreement by either the Sheikh or the Company
     except in the event the Sheikh or the Company jointly
     agreeing that it is desirable in the interest of both
     parties to make certain alterations, deletions or
     additions to this agreement.

                    *     *     *     *     *
     [Article 11(b)] Save as aforesaid this Agreement shall
     not be terminated before the expiration of the period
     specified in Article 1 thereof except by surrender as
     provided in Article 12 or if the Company shall be in
     default under the arbitration provisions of Article 18.

Section five continues:    “A straightforward and direct reading of

them [the stabilization clauses] can lead to the conclusion that

they prohibit any nationalisation.”      Nevertheless, the tribunal

concluded that the expropriation was valid, based on the

following grounds: (1) The stabilization clauses do not prohibit

nationalization in so many words, (2) a stabilization clause
                               - 21 -


could be fully effective only for a period shorter than the

60-year term of the concession agreement, and (3) the

stabilization clauses had lost much of their force through

changes in the relations between the parties since 1948.    Thus,

section five provides:   “a lawful nationalisation of Aminoil’s

undertaking had occurred.”

     The tribunal’s analysis and conclusion with respect to the

stabilization clauses was not unanimous.   Sir Gerald G.

Fitzmaurice disagreed with the majority’s analysis of the

stabilization clauses.   He concluded that the expropriation was

irreconcilable with the stabilization clauses.    Despite that

conclusion, however, Judge Fitzmaurice noted his “entire

agreement with the Operational Part (Dispositif) of the Award”,

i.e., the bottom line, net compensation awarded to Aminoil of

$179,750,764.

          8.    The Question of Indemnification

     The tribunal’s discussion of indemnification in the seventh

section of the award (section seven) is divided into two parts,

the first dealing with “Principles and Methods” and the second

determining amounts due.

     The tribunal begins the first part by recognizing that there

is “a very considerable gap” between Aminoil’s claim, based on

the lost profits value of the concession, and Kuwait’s offer,

based on net book value of the assets expropriated.    Section

seven identifies “appropriate compensation” as the applicable
                               - 22 -


legal standard and recognizes that its task calls for a “concrete

interpretation” of that standard.    Section seven states that a

determination of appropriate compensation “is better carried out

by means of an enquiry into all the circumstances relevant to the

particular concrete case, than through abstract theoretical

discussion.”    Section seven recognizes that, in applying that

standard to the case before it, “there is no room for rules of

compensation that would make nonsense of foreign investment.”

The tribunal adds:   “Compensation then, must be calculated on a

basis such as to warrant the upkeep of a flow of investment in

the future.”

     Considering in that light the circumstances of the case

before it, the tribunal decided that the “legitimate

expectations” of the parties must be the basis for deciding on

compensation.    The tribunal rejected the notion that Aminoil’s

legitimate expectations were to be measured by the then-present

value of the projected net revenues it might have anticipated

over the remaining 30 years of the concession agreement, finding,

instead, that “the Parties adopted a different conception in the

course of their relations and negotiations, - namely that of the

reasonable rate of return.    This it is, therefore, that must

guide the Tribunal.”

     The tribunal then focused more precisely on “the basis on

which the evaluation of the legitimate expectations of Aminoil

must proceed.”   Section seven provides:   “whereas the contract of
                              - 23 -


concession did not forbid nationalisation, the stabilization

clauses * * * were nevertheless not devoid of all consequence,

for they prohibited any measures that would have had a

confiscatory character”; they, therefore, “created for the

concessionaire a legitimate expectation that must be taken into

account.”   The tribunal reiterated, too, that from “the time when

its rate of production reached a satisfactory level, Aminoil was

in the position of an undertaking whose aim was to obtain a

‘reasonable rate of return’ and not speculative profits which, in

practice, it never did realize.”   The tribunal stated further

that “over the years, Aminoil had come to accept the principle of

a moderate estimate of profits, and * * *    it was this that

constituted its legitimate expectation.”    Concluding, the

tribunal stated:

     [The Tribunal] considers it to be just and reasonable
     to take some measure of account of all the elements of
     an undertaking. This leads to a separate appraisal of
     the value, on the one hand of the undertaking itself,
     as a source of profit, and on the other of the totality
     of the assets, and adding together the results
     obtained.

     The tribunal concluded its discussion of principles and

methods by stating that it “is necessary in all cases to consider

the value of the assets as at the date of transfer, taking due

account of the depreciation they have undergone by reason of wear

and tear and obsolescence.”   For reasons explained at length in

the Award, the tribunal rejected the net book values Kuwait

sought.
                                - 24 -


     Finally, the tribunal turned to the amounts due.      It began

that discussion by acknowledging that the joint report was the

source of certain agreed amounts.    It stated that, where the

parties disagreed in the joint report, it adopted an average of

the parties’ amounts.   It stated that, where it did not possess

any joint report figures, it determined for itself other

necessary amounts.   The tribunal then proceeded to “determine the

balance-sheet of the financial rights and obligations of the

Parties as at 19 September, 1977.”       It dealt first with Kuwait’s

claims against Aminoil and determined that Aminoil owed Kuwait

$123,041,000.   In the final paragraph of section seven (paragraph

178), the tribunal fixed Aminoil’s claims against Kuwait and set

forth certain adjustments, including the $123,041,000 owed by

Aminoil to Kuwait, to obtain the basis for the $179 million

payment to be made by Kuwait to Aminoil.      In full, paragraph 178

provides:

     Amounts due to Aminoil -

          (1) These are made up of the values of the
     various components of the undertaking separately
     considered, and of the undertaking itself considered as
     an organic totality - or going concern - therefore as a
     unified whole, the value of which is greater than that
     of its component parts, and which must also take
     account of the legitimate expectations of the owners.
     These principles remain good even if the undertaking
     was due to revert, free of cost, to the concessionary
     Authority in another 30 years, the profits having been
     restricted to a reasonable level.

          (2) As regards the evaluation of the different
     concrete components that constitute the undertaking,
     the Joint Report furnishes acceptable indications
                              - 25 -


     concerning the assets other than fixed assets. But as
     regards the fixed assets, the “net book value” used as
     a basis merely gives a formal accounting figure which,
     in the present case, cannot be considered adequate.

          (3) For the purposes of the present case, and for
     the fixed assets, it is a depreciated replacement value
     that seems appropriate. In consequence, taking that
     basis for the fixed assets, taking the order of value
     indicated in the Joint Report for the non-fixed assets,
     and taking into account the legitimate expectations of
     the concessionaire, the Tribunal comes to the
     conclusion that, at the date of 19 September, 1977, a
     sum estimated at $206,041,000 represented the
     reasonably appraised value of what constituted the
     object of the takeover.

          (4) According to the above mentioned data, the
     sum total of the amount due to Aminoil as at
     19 September, 1977, comes to $206,041,000 less the
     liabilities of $123,041,000, that is to say
     $83,000,000. This represents the outcome of the
     balance-sheet of the rights and obligations of the
     Parties as at 19 September, 1977.

          (5) In order to establish what is due in 1982,
     account must be taken both of a reasonable rate of
     interest, which could be put at 7.5%, and of a level of
     inflation which the Tribunal fixes at an overall rate
     of 10%, - that is to say at a total annual increase of
     17.5% in the amount due, over the amount due for the
     preceding year.

          (6) Capitalizing the above-mentioned figure of
     $83,000,000 at a compound rate of 17.5% annually, gives
     the amount specified in the Operative Section
     (Dispositif) below.

     D.   Petitioner’s Tax Treatment of the Award

     Petitioner took the award into account in determining the

consolidated Federal income tax liability of the affiliated group

for 1982.   Petitioner identified the various components giving

rise to the $179 million payment and made the following

allocations:
                                  - 26 -


Amounts received by Aminoil
under paragraph 178(3):
  Oil Inventory             $10,885,500
  Other Assets               19,080,500
  Fixed Assets              176,075,000
      Subtotal                            206,041,000

Less Aminoil’s liabilities to
Kuwait:
  Per concession agreement   32,228,500
  Per Abu Dhabi Formula      71,963,000
  Due third parties          18,849,500
      Subtotal                            123,041,000
                  Total                                 83,000,000
Plus Amounts received by Am-
inoil under paragraph 178(5):
  7.5% component             41,602,829
 10.0% component             55,147,935
      Subtotal                                          96,750,764
Payment received from Kuwait                                  179,750,764

     Petitioner reported the $55,147,935 identified as the

“10% Component” (and by the Tribunal as the “level of inflation”

adjustment) as an amount realized on a sale or other disposition

of the concession.    Since petitioner believed that Aminoil’s

adjusted basis in the concession was zero, petitioner reported a

gain of $55,147,935.     Petitioner reported that gain as a long-

term capital gain under the authority of section 1231.

     Respondent determined a deficiency in petitioner’s

consolidated income tax liability for 1982 based, in part, on an

adjustment treating the “level of inflation” adjustment not as an

amount realized on the sale or disposition of property but,

rather, as ordinary income.
                               - 27 -



                               OPINION

I.   Graphic Design Issue

      A.   Issue

      We must determine whether the litigated expenses are

currently deductible business expenses.   Respondent determined

that they are capital expenditures and, therefore, not currently

deductible.    The litigated expenses include expenditures relating

to the graphic design of cigarette packaging materials (cartons,

soft-packs, and crush-proof boxes) and cigarette papers, tips,

and other components of the cigarette product, as well as a

relatively small amount of expenditures relating to package

design (the physical construction of the package itself).

      B.   Arguments of the Parties

      Petitioner starts with the premise that expenditures for

ordinary business advertising (to sell a product or service or

for institutional or “goodwill” advertising that keeps the

taxpayer’s name before the public) are deductible under section

162(a) and argues that the litigated expenses give rise to a

benefit that is indistinguishable from the benefit derived from

ordinary business advertising.    Consequently, petitioner argues,

the litigated expenses are also deductible under section 162(a).

Petitioner also argues that, like expenditures for ordinary

business advertising, the litigated expenses represent a
                                - 28 -


recurring, day-to-day business expense, deductible under section

162(a) for that reason alone.    In the alternative, petitioner

argues that the litigated expenses are deductible under section

174.

       Respondent agrees that the litigated expenses are similar to

some expenditures for ordinary business advertising, but he

argues that not all expenditures for ordinary business

advertising are deductible under section 162(a).    Respondent

distinguishes between the costs of developing advertising

campaigns (advertising campaign expenditures) and the costs of

executing those campaigns by way of, for instance, the production

of television commercials (advertising execution expenditures).

Respondent argues that advertising execution expenditures

generally give rise to expenses deductible under section 162

(deductible business expenses) but that advertising campaign

expenditures do not.    Respondent sees a “decisive difference”

between advertising campaign expenditures and advertising

execution expenditures in that the former give rise only to long-

term benefits while the latter give rise principally to short-

term benefits.    Respondent analogizes the litigated expenses to

advertising campaign expenses and argues that the litigated

expenses provide an intangible benefit to Reynolds over the

economic lives of the brands to which they attach.    Consequently,

respondent concludes that the litigated expenses must be
                               - 29 -


capitalized and are not currently deductible business expenses.3

Respondent also argues that the litigated expenses are neither

recurring, day-to-day expenditures nor are they deductible under

section 174.

     C.   Tax Rules Governing Advertising Expenditures

           1.   Introduction

     Petitioner’s principal claim is that “graphic design and

advertising activities are indistinguishable in any way that

would justify their inconsistent tax treatment”.   Petitioner

supports its claim that graphic design and advertising are

indistinguishable by analyzing and comparing the functions of

those activities.   Respondent attempts to counter petitioner’s

functional analysis with a functional analysis of his own,

candidly conceding, however, that his disagreement with

petitioner “is only a matter of degree”.4   Neither party argues


3
     Respondent argues that the litigated expenses are allocable
to particular brands and, as so allocated, give rise to an
economic benefit for the remaining life of that brand.
Accordingly, respondent does not believe that the litigated
expenses have a determinable useful life, and respondent would
allow no depreciation deduction for the litigated expenses. We
need not address the question of a depreciation deduction because
petitioner stands on its claim that the litigated expenses are
deductible business expenses in 1982, and has not argued in the
alternative for capitalization and a depreciation deduction in
1982.
4
     Indeed, the parties have stipulated similar, in part
identical, functions for graphic design and advertising. Compare
(1) “The graphic designs for a product serve to identify the
                                                   (continued...)
                              - 30 -


that the term “advertising” is a term of art for Federal income

tax purposes.   Indeed, respondent implicitly concedes that the

rules with respect to advertising govern the deductibility of the

litigated expenses, although, under respondent's interpretation

of those rules, the litigated expenses are not deductible

business expenses because they are capital expenses.    Moreover,

respondent called as an expert witness Mukesh Bajaj, Ph.D.,

senior associate, Business Valuation Services, Inc.    Dr. Bajaj

was accepted by the Court as an expert in corporate finance and

business valuation, and his written report was received into

evidence as his expert testimony.   Dr. Bajaj testified that there

is an accepted textbook definition of advertising.5    On cross-

examination, he conceded that cigarette package graphic designs

qualify as advertising under that definition.    On brief,

respondent agrees that cigarette pack graphic designs fit the

textbook definition of advertising.    We are, thus, satisfied


4
     (...continued)
product, convey information, attract attention at point of sale
when the retailer displays the pack, and other purposes.”, with
(2) “The advertising for a product or group of products serves to
convey information, project the image chosen for the positioning
of the product or products, attract consumer attention to the
product or products, and other purposes.”
5
     Dr. Bajaj testified that the accepted, current textbook
definition of advertising is the 1948 definition of the American
Marketing Association, which he summarized as follows: “any paid
form of non-personal presentation and promotion of ideas, goods,
or services by an identified sponsor, which involves the use of
mass media.” (Emphasis omitted.)
                                - 31 -


that, on the evidence before us, petitioner has proven that the

litigated expenses are advertising expenditures, and we so find.

          2.     Deductible Business Expenses

     Section 162(a) allows as a deduction "all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business".      Generally, no deduction is

allowed for any capital expenditure.     Compare sec. 179 with sec.

263(a)(1).6    The Supreme Court has held that a taxpayer’s

expenditure that “serves to create or enhance * * * a separate

and distinct” asset must be capitalized.        Commissioner v. Lincoln

Sav. & Loan Association, 403 U.S. 345, 354 (1971).       Subsequently,

the Court held that, although the separate-or-distinct-asset

standard is a sufficient condition for capitalization, it is not

a necessary condition and that an expenditure that gives rise to

more than incidental future benefits, whether or not the

expenditure gives rise to a separate and distinct asset, may

require capitalization.     INDOPCO, Inc. v. Commissioner, 503 U.S.

79, 87 (1992).




6
     In certain circumstances, capital expenditures may be
recovered by deductions taken over the useful life of the
resulting property or over some other predetermined period.
See, e.g., secs. 167, 197 (as added by the Omnibus Budget
Reconciliation Act of 1993, Pub. L. 103-66, sec. 13261(a),
107 Stat. 313, 532, effective generally for property acquired
after Aug. 10, 1993). We are not here concerned with any such
recovery. See supra n.3.
                              - 32 -


     Although the mere presence of an incidental future
     benefit--”some future aspect”--may not warrant
     capitalization, a taxpayer’s realization of benefits
     beyond the year in which the expenditure is incurred is
     undeniably important in determining whether the
     appropriate tax treatment is immediate deduction or
     capitalization. * * *

Id. (emphasis added).   We have characterized the inquiry as to

whether an expenditure may be deducted under section 162(a) or

must be capitalized as “an inquiry into the proper time to give

tax effect to the expenditure.”     A.E. Staley Manufacturing Co. v.

Commissioner, 105 T.C. 166, 193, revd. and remanded 119 F.3d 482

(7th Cir. 1997).   In A.E. Staley Manufacturing Co., we stated

that the inquiry is “fact specific”, and we described the general

nature of the inquiry as follows:

          Assuming that the expenditure is ordinary and
     necessary in the operation of the taxpayer’s business,
     the answer to the question of whether the expenditure
     is a deduction allowable as a business expense must be
     determined from the nature of the expenditure itself
     which in turn depends on the extent and permanence of
     the work accomplished by the expenditure.

Id. at 193-194 (quoting 6 Mertens, Law of Federal Income

Taxation, sec. 25.37, at 118 (1992 rev.).

     3.   Ordinary Business Advertising

     “Advertising” is commonly defined as:    “The activity of

attracting public attention to a product or business, as by paid

announcements in print or on the air.”    The American Heritage
                                - 33 -


Dictionary of the English Language 26 (3d ed. 1992).7   A business

may advertise principally to attract customers, and there is no

doubt that such advertising may contribute to the goodwill

enjoyed by the business.   “Goodwill”, the Supreme Court stated,

“is the expectancy of continued patronage”.   Newark Morning

Ledger Co. v. United States, 507 U.S. 546, 555-556 (1993) (“the

shorthand description of good-will as the expectancy of continued

patronage * * * provides a useful label with which to identify

the total of all the imponderable qualities that attract

customers to the business” (internal quotation marks and

citations omitted)).   Thus, if an expenditure for ordinary

business advertising gives rise to goodwill, then, at least in

theory, the proper time to give tax effect to the expenditure may

be a period running beyond the taxable year of expenditure.

Nevertheless, the regulations interpreting section 162 include

“advertising and other selling expenses” among the class of

deductible business expenses:

     Business expenses deductible from gross income include
     the ordinary and necessary expenditures directly
     connected with or pertaining to the taxpayer's trade or
     business * * * Among the items included in business
     expenses are * * * advertising and other selling
     expenses * * *




7
     We see no pertinent difference between this definition and
the “textbook” definition testified to by Dr. Bajaj. See supra
n.5.
                              - 34 -


Section 1.162-1(a), Income Tax Regs.   The regulations do not

further describe the nature of those advertising and selling

expenses (hereafter, without distinction, advertising expenses)

that are deductible business expenses, although section 1.162-

20(a)(2), Income Tax Regs., provides that expenditures for

institutional or “goodwill” advertising that keeps the taxpayer’s

name before the public are generally deductible business expenses

“provided the expenditures are related to the patronage the

taxpayer might reasonably expect in the future.”   The

regulations, thus, suggest that expenditures for ordinary

business advertising are not subject to the usual inquiry when it

comes to the question of the proper time to give tax effect to

such an expenditure.

     Sections 1.162-1(a) and 20(a)(2), Income Tax Regs., however

predates INDOPCO, Inc. v. Commissioner, supra at 87, in which the

Supreme Court concluded that significant future benefits were

“undeniably important” in making the capitalization inquiry.    See

also FMR Corp. & Subs. v. Commissioner, 110 T.C. ___ (1998) (slip

op. at 39).   Subsequently, the Commissioner ruled that INDOPCO,

Inc. does not affect the treatment of advertising expenditures

under section 162(a).   In pertinent part, Rev. Rul. 92-80, 1992-2

C.B. 57, provides:

          The Indopco decision does not affect the treatment
     of advertising costs under section 162(a) of the Code.
     These costs are generally deductible under that section
                              - 35 -


     even though advertising may have some future effect on
     business activities, as in the case of institutional or
     goodwill advertising. See section 1.162-1(a) and
     section 1.162-20(a)(2) of the regulations. Only in the
     unusual circumstance where advertising is directed
     towards obtaining future benefits significantly beyond
     those traditionally associated with ordinary product
     advertising or with institutional or goodwill
     advertising, must the costs of that advertising be
     capitalized. See, e.g., Cleveland Electric
     Illuminating Co. v. United States, 7 Cl. Ct. 220 (1975)
     (capitalization of advertising costs incurred to allay
     public opposition to the granting of a license to
     construct a nuclear power plant).

     Although Rev. Rul. 92-80, supra, may raise some question of

just what benefits are traditionally associated with ordinary

product advertising or with institutional or goodwill

advertising, there is no doubt that such traditional benefits

include not only patronage but also the expectancy of patronage

(i.e., “goodwill”).   Compare sec. 1.162-1(a), Income Tax Regs.

(deductible business expenses include “advertising and other

selling expenses”), with sec. 1.162-20(a)(2), Income Tax Regs.

(same as to institutional or goodwill advertising “provided the

expenditures are related to the patronage the taxpayer might

reasonably expect in the future”).     Thus, even if advertising is

directed solely at future patronage or goodwill (i.e., ordinary

business advertising), Rev. Rul. 92-80, supra, indicates that

normally the costs are deductible.

     The unusual treatment of expenditures for ordinary business

advertising manifest in Rev. Rul. 92-80, supra, is longstanding.
                               - 36 -


Its genesis is in efforts by taxpayers in the early years of

income taxation to capitalize the costs of large-scale

advertising campaigns and to amortize the capitalized amounts

over a period of years, efforts that were consistently opposed by

the Commissioner on the ground that allocating advertising

expenditures between current expenses and capital outlays was not

feasible.   See, e.g., Northwestern Yeast Co. v. Commissioner,

5 B.T.A. 232, 237 (1926).   Although the courts did not entirely

foreclose the propriety of capitalizing some advertising

expenditures, taxpayers found it difficult to prove an

appropriate allocation between current and long-term benefits.

In time, this insistence on evidence hardened into a rule of law

that capitalization is proper only if the taxpayer can establish

“that the future benefits can be determined precisely and are not

of indefinite duration.”    A. Finkenberg’s Sons, Inc. v.

Commissioner, 17 T.C. 973, 982-983 (1951); see also E.H. Sheldon

& Co. v. Commissioner, 214 F.2d 655, 659 (6th Cir. 1954)

(taxpayer must show “with reasonable certainty the benefits

resulting in later years from the expenditure”), affg. in part,

and revg. and remanding in part 19 T.C. 481 (1952).   See the

discussion of advertising expenses in Bittker & Lokken, Federal

Taxation of Income, Estates and Gifts, par. 20.4.5 at 20-86 to

20-88 (2d ed. 1989).   But see Durovic v. Commissioner, 542 F.2d

1328 (7th Cir. 1976) (cost of free samples must be capitalized;
                             - 37 -


amortization denied in absence of proof of limited life), affg.

65 T.C. 480 (1975).

     Although the case law admits the possibility of allocation

between the short- and long-term benefits of advertising

expenditures and, thus, would provide a basis for the

Commissioner to insist that a taxpayer prove the portion of his

advertising expenditures allocable to current benefits, the

authorities previously cited, section 1.162-20(a)(2), Income Tax

Regs., and Rev. Rul. 92-80, supra, establish that the Secretary

and the Commissioner, respectively, have eschewed that approach

with respect to ordinary business advertising, even if long-term

benefits (e.g., goodwill) are the taxpayer’s primary objective.

See also Rev. Rul. 68-561, 1968-2 C.B. 117 (concerning a gas

company’s campaign to increase consumption by encouraging the

construction of “all gas” homes and the conversion of existing

homes to gas and distinguishing between cash allowances to

builders and homeowners, which must be capitalized because the

expected benefit is increased sales of gas beyond the year of

expenditure, and direct advertising costs of the sales campaign,

which may be treated as ordinary business expenses because “less

directly and significantly productive of intangible assets having

a value extending beyond the taxable years in which they were

paid or incurred”).
                              - 38 -


     The result, as a practical matter, is that, notwithstanding

certain long-term benefits, expenditures for ordinary business

advertising are ordinary business expenses if the taxpayer can

show a sufficient connection between the expenditure and the

taxpayer’s business.   See Burrous v. Commissioner, T.C. Memo.

1977-364 (taxpayer failed to prove a proximate relationship

between midget auto racing and any increase in his accounting

business).   The only significant exceptions are that

(1) expenditures for foreign-based broadcast advertising to the

United States are disallowed if a like deduction is not allowed

by the foreign country for United States based broadcast

advertising to that country and (2) expenditures to advertise in

a political party’s convention program and certain other

political publications cannot be deducted.   Secs. 162(j),

276(a)(1), respectively.8   Generally, expenditures for

billboards, signs, and other tangible assets associated with

advertising remain subject to the usual rules with respect to

capitalization.   See, e.g., Best Lock Corp. v. Commissioner,


8
     Sec. 162(j) was added by the Trade and Tariff Act of 1984,
Pub. L. 98-573, sec. 232(a), 98 Stat. 2991, and is effective for
taxable years beginning after Oct. 30, 1984. Under a provision
now repealed, taxpayers who elected to capitalize advertising
expenditures in computing their liability under the now defunct
wartime excise profits taxes had to follow a consistent practice
for subsequent expenditures. Sec. 263(b) (repealed by the
Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-508, sec.
11801(a)(16), 104 Stat. 1388-520); sec. 1.162-14, Income Tax
Regs.
                              - 39 -


31 T.C. 1217, 1235 (1959) (“The amounts paid in 1951 and 1952 to

produce * * * [a sales catalog] were capital items contributing

to earning income for several years in the future and not

ordinary and necessary expenses of doing business in 1951 and

1952.”); Alabama Coca-Cola Bottling Co. v. Commissioner, T.C.

Memo. 1969-123 (costs of signs, clocks, and scoreboards, having a

useful life of 5 years not deductible business expense).    But see

E.H. Sheldon & Co. v. Commissioner, 214 F.2d 655, 659 (6th Cir.

1954), (expenditures to produce sales catalog likely to be used

for several years deductible business expense) supra at 659.

     D.   Advertising Campaign Expenditures

     Respondent would have us distinguish between the creation of

an advertising campaign and the execution of that campaign:

          A marketing [advertising] campaign does not sell
     anything. It prescribes a long-term intangible
     marketing concept, its imagery, its theme, and its
     slogan and/or message. That marketing concept is then
     portrayed in advertisements with ever-changing art work
     to maintain customer interest in the campaign. * * *

Respondent argues that advertising campaign expenditures are not

deductible business expenses because:   “The cost of developing a

successful marketing campaign is expected to generate benefits

for future indefinite business operations.”   To respondent,

advertising campaign expenditures are distinguishable from

advertising execution expenditures on the basis that the former

are solely long-term oriented, and that is a “decisive

difference” foreclosing an immediate deduction.
                              - 40 -


     It is clear, however, that to distinguish advertising

campaign expenditures from advertising execution expenditures

solely on the basis of the taxpayer's expectations regarding the

duration of the expected benefits is insufficient to require

capitalization of an advertising expenditure.   See sec. 1.162-

1(a), 20(a)(2) (providing for the general deductibility of

"goodwill" advertising); supra sec. I.C.3.   So long as all of the

benefits resulting from advertising campaign expenditures are

among the traditional benefits associated with ordinary business

advertising, the regulations, as interpreted by respondent’s own

ruling, Rev. Rul. 92-80, 1992-2 C.B. 57, preclude capitalization.

     Nevertheless, respondent argues that advertising campaign

expenditures (and, likewise, the litigated expenses) create

intangible assets and benefits that are not among the benefits

traditionally associated with ordinary business advertising

(e.g., goodwill).   Respondent describes those benefits of

advertising campaign expenditures as certain “legal rights and

economic interests” of a long-term nature.   Respondent identifies

the pertinent legal rights as the Federal statutory rights and

common-law trademark rights that attach to “trade dress”, a term

that the courts have used to describe, “essentially * * * [the]

total image and overall appearance” of a product.    See Philip

Morris Inc. v. Star Tobacco Corp., 879 F. Supp. 379, 383

(S.D.N.Y. 1995), and authorities cited therein.     Respondent
                              - 41 -


identifies the economic interests that are benefited by the

litigated expenses as the various brands of cigarettes to which

the litigated expenses pertain.   Respondent adopts the term

“brand equity” to define the economic value inherent in a

successful brand.   Dr. Bajaj testified as to the major elements

of brand equity: (1) brand name awareness, (2) brand loyalty,

(3) perceived quality, and (4) brand association.   He describes

those elements as follows:

     Brand name awareness comes from advertising, as well as
     from previous use or from word or mouth. Brand loyalty
     is primarily a result of being satisfied with the
     product from prior use. Perceived quality has two main
     elements: (1) a user understands the product and has
     an opinion on its quality, [and] (2) advertising and
     package design can create a “personality” for the
     product. For example, Mercedes cars are considered
     luxurious, while Volvo cars are considered safe. * * *
     Finally, brand associations can be about imagery
     created through advertising or other means. * * *

Dr. Bajaj is of the opinion that the litigated expenses “created

intangible assets that are inseparable from brand equity and

goodwill”.

     Petitioner does not dispute that (1) advertising campaign

expenditures (or expenditures for graphic design) may contribute

to trade dress or (2) trade dress is protected by law.

Petitioner points out, however, that trade dress is in fact also

a product of ordinary business advertising, including what

respondent labels as advertising executions.   See id. (“A

product’s image may be created by words, symbols, collections of
                              - 42 -


colors and designs, or advertising materials or techniques”

(internal quotation marks omitted; emphasis added.)).   Petitioner

argues that, in Philip Morris, Inc. v. Star Tobacco Corp., supra,

the image and overall appearance of the Marlboro brand that

Philip Morris sought to protect by its trade dress infringement

action was, in substantial part, its advertising executions:

     The trade dress Philip Morris seeks to protect consists
     of specific manifestations of a Western motif: the
     picture of a cowboy on a cigarette pack; figures of
     cowboys who have come over time to be known as the
     “Marlboro Man”; and those evocative stretches of the
     Western landscape, not to be found on any map or
     ordinance survey, called “Marlboro Country.” * * *

Id. at 385.   Petitioner points out that the parties have

stipulated that, with respect to Philip Morris’ “Come to Marlboro

Country” campaign:   “The campaign is characterized by a masculine

cowboy image in a rugged western setting.   The individual

executions show the cowboy in various settings -- roping a steer,

riding a horse into the sunset, etc.”   Petitioner further cites

other trade dress cases holding that a variety of other marketing

materials and techniques are subject to trade dress protection.

See Computer Care v. Serv. Sys. Enters., Inc., 982 F.2d 1063,

1065-1071 (7th Cir. 1992); Original Appalachian Artworks, Inc. v.

Toy Loft, Inc., 684 F.2d 821, 831 (11th Cir. 1982); Chuck Blore &

Don Richman, Inc. v. 20/20 Adver., Inc., 674 F. Supp. 671, 680-

681 (D. Minn. 1987).   We agree with petitioner’s analysis and

conclude that both advertising campaign expenditures and
                              - 43 -


advertising execution expenditures account for at least some of

the value of the typical trade dress.     Since advertising

execution expenditures are ordinary business expenses, we

conclude that the long-term benefit associated with trade dress

is a benefit traditionally associated with ordinary business

advertising.   It therefore cannot serve as a basis to require the

capitalization of the litigated expenses.

     In connection with his discussion of trade dress, respondent

refers to the copyright and trademark protection available to the

various elements making up trade dress.     The parties have

stipulated, however, that Reynolds placed notices of copyright on

its advertising executions, and exhibits in evidence establish

that other companies did the same.     Thus, we conclude that

copyright protection afforded to copyrightable advertising

materials is a traditional benefit associated with ordinary

business advertising, and, for that reason, it cannot serve as

the basis for requiring the capitalization of the litigated

expenses.

     With respect to trademark protection, the parties have

stipulated that none of the litigated expenses were incurred in

connection with the purchase, creation, acquisition, protection,

expansion, registration, or defense of a trademark or trade name.

     As to the economic interests of Reynolds benefited by the

litigated expenses, petitioner agrees with respondent’s expert,
                                - 44 -


Dr. Bajaj, that the litigated expenses created intangible assets

that are inseparable from brand equity and goodwill.    Indeed,

petitioner argues:     “[T]he record uniformly shows that successful

graphic designs, together with successful advertising and other

marketing activities, combine to build an overall brand value or

equity -- the marketing terms for goodwill.”    Petitioner argues

that, nevertheless, the litigated expenses are deductible.       We

agree.    We think that “brand equity”, as described by Dr. Bajaj,

represents “goodwill”, as we understand that term (i.e., “the

expectancy of continued patronage”).     See supra sec. I.C.3.    That

being the case, and goodwill clearly being a traditional benefit

associated with ordinary business advertising, we must conclude

that the litigated expenses are not capital expenditures simply

because they contribute to brand equity.

     E.   Conclusion

     We have found that the litigated expenses are advertising

expenditures.9   Respondent classifies the litigated expenses as

advertising campaign expenditures and would have us distinguish

between such expenditures and advertising execution expenditures

on the basis that the latter give rise principally to short-term


9
     Neither party has asked us to address separately the small
portion (approximately 1.5 percent) of the litigated expenses
that were package design expenditures. Indeed, it is only
petitioner that, in its opening brief, drew our attention to the
distinction between graphic design and package design, see
Findings of Fact, supra sec. II.B., and respondent has not
alleged that we should afford them different treatment.
                               - 45 -


benefits while the former give rise only to long-term benefits.

The experience of our predecessor, the Board of Tax Appeals, and

other courts in an earlier era lead us to doubt the sharpness of

that distinction.10   Moreover, no case distinguishes between

advertising execution and campaign expenditures, and the long-

term, short-term distinction respondent would draw is

incompatible with section 1.162-1(a) and 20(a)(2), Income Tax

Regs., and Rev. Rul. 92-80, 1992-2 C.B. 57.    Respondent’s

distinction will not hold; the litigated expenses are advertising

expenditures that are ordinary business expenses.

       Because we have concluded that the litigated expenses are

ordinary business expenses on the grounds stated, we need not

address petitioner’s alternative theories that the litigated

expenses are recurring expenses or are deductible under section

174.


10
     See, e.g., Northwestern Yeast Co. v. Commissioner, 5 B.T.A.
232, 237 (1926), discussed supra sec. I.C.3., and quoted in part
as follows:

             Generally and theoretically, therefore, it is safe
       to say that some part of the cost of a campaign or
       system of promotion may be of permanent significance
       and may be regarded as a capital investment rather than
       a deductible expense. But how far in a given case the
       recognition of this doctrine may require the
       capitalization of some expenditures and the charging
       off of others is hard to say. Clearly, when the
       question is submitted for judicial consideration, it
       may not be answered ab inconvenienti by an arbitrary
       rule.
                                - 46 -


II.   Expropriation Issue

      A.   Description of the Issue

      On September 19, 1977, Kuwait terminated the concession

enjoyed by Aminoil to explore for and exploit certain natural

resources in a Kuwaiti frontier area known as the Neutral Zone

and expropriated certain of Aminoil’s assets in Kuwait.     Aminoil

protested the termination of the concession and the

expropriation, and Aminoil and Kuwait entered into an agreement

to arbitrate the resulting dispute.      A tribunal was established

to carry out that arbitration, and, on March 24, 1982, the

tribunal made an award to Aminoil in the amount of $179,750,764.

Kuwait honored the decision of the tribunal and paid Aminoil the

award on July 1, 1982 (the $179 million payment).     The reasoning

of the tribunal precedes its statement of the amount of the award

and indicates that the tribunal reached that amount by steps.

First, the tribunal determined the sum of Aminoil’s debts to

Kuwait and the sum of certain amounts due Aminoil from Kuwait.

The difference of those two sums was a net amount in Aminoil’s

favor.     The tribunal then determined the total amount due Aminoil

by adding to the subtotal it had determined (1) an interest

amount and (2) an amount described as a “level of inflation”

amount (10 percent of the amount due compounded from the

expropriation date to the date of the award).     For purposes of

taking the award into account for Federal income tax purposes,
                              - 47 -


petitioner made allocations based on the methodology of the

tribunal.   Petitioner then determined what income tax consequence

to assign to each of those allocations and reported those

consequences accordingly.   Respondent agrees with petitioner’s

allocations and with all but one of the consequences determined

by petitioner.   Petitioner treated $55,147,935, the amount

described by the tribunal as the “level of inflation” adjustment,

as an amount realized on the sale or other disposition of the

concession.   Respondent does not agree with petitioner that the

“level of inflation” adjustment is an amount realized on the sale

or other disposition of the concession (which would give rise to

a long-term capital gain in an equal amount).   Respondent

believes that the “level of inflation” adjustment (the disputed

item) is ordinary income in the nature of interest.   As the

parties have framed the issue, we must determine whether the

disputed item is as petitioner describes it or is as respondent

describes it.

     B.   Arguments of the Parties

     Petitioner’s argument is as follows:

          Petitioners contend that the unexplained 10%
     “inflation” factor [the disputed item] is taxable as
     capital gain under section 1231 because it represented
     disguised compensation for Kuwait’s premature
     termination of Aminoil’s Concession, for which there is
     no identifiable compensation on the face of the Award.

     Respondent’s argument is as follows:
                               - 48 -


          The [tribunal determined that the] value of
     Aminoil's nationalized operations on September 19, 1977
     was $83,000,000, net of liabilities owing from Aminoil
     to Kuwait (i.e., $206,041,000 less $123,041,000). The
     five year delay in payment (from September 19, 1977
     through July 1, 1982) caused Kuwait to accrue
     substantial additional debt owing to Aminoil. Had
     there been no delay in payment, Kuwait would have
     simply paid Aminoil $83,000,000. The "inflation"
     factor, like the "interest" factor, was compensation
     for the delay in payment, and therefore, it is properly
     treated as ordinary income under section 61.

     C.   Discussion

           1.   Introduction

     The parties agree that the disputed item was received

pursuant to the award and that the intention of the tribunal

governs as to whether the disputed item is disguised compensation

for the concession or a payment in the nature of interest.

Respondent argues that the award is clear on its face and that

the disputed item is in the nature of interest.   Respondent

argues further that we are constrained, in any event, by the

Convention on the Recognition and Enforcement of Foreign Arbitral

Awards of June 10, 1958 (the Convention), 21 U.S.T. 2517,

(entered into force Dec. 29, 1970), from “reevaluat[ing] the

matters decided by the Tribunal”.   We shall first determine

whether the Convention constrains us from interpreting the award.

Since we believe that it does not, we shall then consider whether

the award is ambiguous.   Since we believe that it is, we shall

interpret it, using the tools at our disposal.    As will be seen,

we agree with petitioner’s interpretation of the award.
                                - 49 -


          2.     Authority To Interpret the Award

     The award results from the decision of the tribunal, which

came into being and obtained jurisdiction from the arbitration

agreement.     Pursuant to the Convention, the United States must

recognize the award as binding and make its courts available for

enforcement of the award.     See Article II of the Convention;

21 U.S.T. 2519.     We are not, however, considering an action to

enforce the award, nor are we, in any way, determining the rights

of the parties to the award inter se.     This is a proceeding to

redetermine an income tax deficiency, and, with respect to the

award, our inquiry is limited to the meaning of certain words

petitioner claims are ambiguous.     The Convention neither

precludes our inquiry into whether the award is ambiguous, nor,

if we find it to be ambiguous, from interpreting it.     Respondent

has advanced no reason other than the Convention as to why we

should refrain from considering whether the award is ambiguous;

since we are not persuaded by respondent’s Convention argument,

we shall consider whether the award is ambiguous.



          3.     The Award Is Ambiguous

     The tribunal awarded Aminoil $179,750,764, an amount that

the tribunal reached by a process of calculation.     The majority

of the award sets forth the premises and reasoning of the

tribunal leading to that calculation.     We shall consider those
                                - 50 -


premises and reasoning, in light of the arbitration agreement, in

determining whether the award is ambiguous as it pertains to the

disputed item.   We find that it is.

     We find most persuasive the seventh section of the award, in

which the tribunal first addressed “Principles and Methods” of

indemnification and determined that Aminoil must be compensated

for its “legitimate expectations” of a “reasonable rate of

return” from its terminated concession.    The tribunal

specifically included as a principle upon which to base the

compensation due Aminoil that some measure of account must be

taken of “all” of the elements of Aminoil’s undertaking.     That

led the tribunal to conclude:    “This leads to a separate

appraisal of the value, on the one hand of the undertaking

itself, as a source of profit, and on the other of the totality

of the assets, and adding together the results obtained.”     In the

tribunal’s introduction to its discussion of “Amounts due to

Aminoil” (paragraph 178), the tribunal further indicates that an

amount is due Aminoil for the value of the concession measured by

projected loss of future profits:

     These [”Amounts due to Aminoil”] are made up of the
     values of the various components of the undertaking
     separately considered, and of the undertaking itself
     considered as an organic totality - or going concern -
     therefore as a unified whole, the value of which is
     greater than that of its component parts, and which
     must also take account of the legitimate expectations
     of the owners. These principles remain good even if
     the undertaking was due to revert, free of cost, to the
                              - 51 -


     concessionairy Authority in another 30 years, the
     profits having been restricted to a reasonable level.

In its final statement on the subject, the tribunal ruled that:

     taking that basis [”depreciated replacement value”] for
     the fixed assets, taking the order of value indicated
     in the Joint Report for the non-fixed assets, and
     taking into account the legitimate expectations of the
     concessionaire, the Tribunal comes to the conclusion
     that, as the date of 19 September, 1977, a sum
     estimated at $206,041,000 represented the reasonably
     appraised value of what constituted the object of the
     takeover.

Since $206,041,000 (exclusive of the compounded 10 percent “level

of inflation” the tribunal added to it) is itself less than the

sum of $185,305,000 (the only figure before the tribunal for the

depreciated replacement value of the fixed assets) and

$29,966,000 (the average value of the non-fixed assets provided

by Aminoil and Kuwait), there is an unresolved tension between

those numbers and the tribunal’s statement that it is also

compensating Aminoil for its “legitimate expectations” of a

“reasonable rate of return” from its terminated concession.    That

leads us to believe that the award is ambiguous.

     We are also led to believe that the award is ambiguous

because of the limited jurisdiction of the tribunal.   The

tribunal was limited by Article III of the arbitration agreement

to granting Aminoil (apart from any amounts “in respect of

royalties, taxes or other obligations,” none of which were

granted Aminoil) (1) “compensation * * * in respect of assets”,

(2) “damages * * *   in respect of termination [of the concession
                               - 52 -


agreement], and (3) “interest”.    As a matter of interpretation,

therefore, the tribunal’s provision in the award of the compound

10-percent per annum “level of inflation” must fall within one or

another of those categories or be outside of the tribunal’s scope

of authority.    We have no reason to believe that the tribunal

acted outside of the scope of its authority, and we reject that

possibility.    Moreover, language in paragraph 178 of the award

(“Amounts due to Aminoil”) indicates that the disputed item is

not within the category of interest.    In subparagraph (5) of

paragraph 178, the tribunal expressly differentiates between “a

reasonable rate of interest, which could be put at 7.5%,” and “a

level of inflation which the Tribunal fixes at an overall rate of

10%,” which suggests that (1) the tribunal considered “interest”

and “the level of inflation” to be separate items and (2) the

latter, therefore, must be either “compensation” or “damages”.

     The tribunal’s reasoning is, thus, ambiguous as to how it

came to measure the amount of compensation owing to Aminoil and

whether the tribunal might have taken into account any value

measured by the potential of the concession to generate profits.

Petitioner’s argument that the tribunal’s compensation did

include an element of compensation measured by loss of future

profit in a disguised way--specifically, through the “level of

inflation”--is plausible.    In contrast, respondent failed to

persuade us that the award is clear on its face or that the
                                 - 53 -


disputed amount, necessarily, is in the nature of interest.        We

find that the award is ambiguous with respect to the disputed

item.

             4.   Extrinsic Evidence

        Since we cannot resolve the ambiguity with respect to the

disputed item from the terms of the award (or the arbitration

agreement, from which it springs), we must turn to extrinsic

evidence to determine its meaning.        Cf. North W. Life Assurance

Co. v. Commissioner, 107 T.C. 363, 382 (1996) (with respect to

the language of a treaty, “when language is susceptible to

differing interpretations, extrinsic materials bearing on the

parties’ intent should be considered.”); Woods v. Commissioner,

92 T.C. 776, 780 (1989) (similar, with respect to a consent

extending time to assess tax); Church v. Commissioner, 80 T.C.

1104, 1107 (1983) (evidence extrinsic to jury verdict considered

to determine nature of monetary award); Johnston v. Commissioner,

42 T.C. 880, 882 (1964) (history of lump-sum condemnation award

considered to determine allocation of proceeds).

            5.    Expert Testimony of Charles N. Brower

        Petitioner argues that the award is ambiguous with respect

to the disputed item because the tribunal used the disputed item

to disguise its award to Aminoil of compensation for Kuwait’s

premature termination of the concession.       Petitioner relies

principally on the expert testimony of Charles N. Brower to prove
                              - 54 -


that point.   By experience, Mr. Brower is knowledgeable

concerning legal issues involving compensation for expropriation

under public international law and the practice of international

arbitration involving such disputes.11    Mr. Brower was accepted

by the Court as an expert witness.     The Court found Mr. Brower’s

testimony to be forthright and credible.

     Mr. Brower has an opinion as to the compatibility of the

tribunal’s reasoning with international law.    He believes that it

is impossible to determine from the face of the award whether or

not the tribunal’s award of compensation to Aminoil is consistent

with relevant principles of public international law (which was

the law applied by the tribunal).    He is of the opinion that the

tribunal’s award of compensation to Aminoil would in fact be

consistent with such principles, however, if, but only if, the

“level of inflation”, “for which there was no precedent



11
     Mr. Brower’s credentials are impressive: During the period
1969-1973 he served in the U.S. Department of State, successively
as assistant legal adviser for European affairs, deputy legal
adviser, and acting legal adviser. In that last position, he was
the principal international lawyer for the Government of the
United States in addition to being the chief lawyer for the
Secretary of State and the U.S. Department of State. He was
responsible for both the pursuit and defense of international
claims involving the Unites States. From 1984 to 1988, he served
full-time as a judge of the Iran-U.S. Claims Tribunal in the
Hague. He is currently in private practice as a member of the
law firm of White & Case. He serves by designation of the United
States as a member of the Register of Experts of the United
Nations Compensation Commission in Geneva, as well as serving on
the Secretary of State’s Advisory Committee on Public
International Law.
                              - 55 -


whatsoever in international law”, is regarded as compensation to

Aminoil for expropriation of the concession, “which otherwise

would have extended for 30 years into the future.”    He bases that

latter conclusion on three assumptions: (1) the tribunal did not

exceed its authority; (2) because the tribunal held the

expropriation to be lawful, international law required

compensation for the “value of the undertaking”, which includes

both a value for the fixed and non-fixed assets taken and a value

for the concession rights; and, (3) the nominal compensation

recited by the tribunal represents only the sum of the

depreciated replacement value of the fixed assets and the

accepted value of the non-fixed assets.    Mr. Brower’s reasoning

leading to his third assumption is the same as our reasoning

leading to our conclusion that there is an “unresolved tension”

between the tribunal’s numbers and its representations concerning

compensation for Aminoil’s “legitimate expectations”.    See supra

sec. III.B.4.   Mr. Brower concludes:   “Thus, the Tribunal could

not within the range of $206,041,000 have granted both the

undisputed value of the expropriated assets and have awarded

anything in respect of the concession.    Only the ‘level of

inflation’ could have done that.”

     Mr. Brower is also of the opinion that the tribunal’s

“studied opacity” with respect to any element of the awards being

measured by loss of profits is consistent with relevant practices
                              - 56 -


in international arbitration cases.     In short, he believes that

political considerations may have played a significant part in

the tribunal’s choice of language.     Mr. Brower believes that

international arbitral tribunals choose their language carefully

to insure that both parties will honor the award, particularly in

disputes involving sovereign states, which may hinder enforcement

by invoking the doctrine of sovereign immunity.     In particular,

Mr. Brower believes that arbitrators called upon to rule on

allegations of unlawful actions by a sovereign conventionally

exhibit a certain sensitivity to the political framework within

which the case arises.   He believes that sovereign states

invariably and vigorously resist accusations of unlawfulness, not

only because of the higher compensation a finding of unlawfulness

might entail but also, and more importantly, because no

government wishes to be branded before the world as having acted

unlawfully, particularly if it wishes to encourage future foreign

investment.   Mr. Brower has examined the award and believes that

it provides “abundant evidence” of the tribunal’s “attention to

pragmatic and political concerns”.     He surmises that Kuwait would

not have wanted any award of compensation either to state

explicitly or to suggest impliedly, by its evident amount or by

its nature, unlawfulness.   Mr. Brower states:

     In particular, Kuwait would have wished to avoid an
     award which, even while finding it acted lawfully,
     appeared to grant compensation reflecting the value of
     what was expropriated at the time of the award (instead
                              - 57 -


     of on the date of expropriation [the former being a
     consequence of an unlawful expropriation]), or a value
     measured to any degree by loss of profit, or both,
     because the former is consistent only with unlawfulness
     and the later may suggest it (particularly to Kuwait).
     * * *

Mr. Brower also believes that other factors would have influenced

Kuwait to avoid any explicit compensation for lost profits.

Among those factors were (1) American involvement in encouraging

Kuwait into the arbitration and (2) OPEC’s stated policy that

compensation to Western oil companies should be based only on

book value and that any other basis for compensation, including,

in particular, any valuation measured by lost profit, should be

refused.   He believes that Kuwait would have been reluctant to

agree openly to an award inconsistent with OPEC’s policy,

particularly against a background of what other states important

to Kuwait might have characterized as “American pressure.”

     Mr. Brower also takes note of the separate opinion of Judge

Fitzmaurice, who agreed with the operative section (which

consists only of the actual award of a lump sum of $179,750,764),

while, at the same time, finding that the expropriation was

irreconcilable with the stabilization clauses and thus,

Mr. Brower concludes, unlawful.   Mr. Brower concludes that Judge

Fitzmaurice agreed with the operative section because, in his

view, it constituted proper compensation for an unlawful

expropriation.
                              - 58 -


     Taking all of the above into consideration, Mr. Brower is of

the opinion that the tribunal reached a compromise (in part to

obtain unanimity) whereby it (1) found Kuwait to have acted

lawfully, notwithstanding that, doctrinally, that finding was

highly questionable; and (2) structured the compensation so that

it would not, on its face, reflect either (A) a value as of the

date of the award or (B) any value measured by loss of profit;

but (3) supplied such compensation de facto, in both respects, in

a manner that would not be obvious, viz, by providing for the

“level of inflation” adjustment.

     6.   Respondent’s Position

     Respondent’s position is that extrinsic evidence is

unnecessary:

          The basic problem with petitioner’s argument is
     that it is based on factual claims which directly
     contradict the text of the Award. * * * The Award
     does not state or imply that the Tribunal used the
     inflation factor to “disguise” a particular type of
     compensation, and there is simply no reason to find
     otherwise. * * *

We have, however, found that the award is ambiguous, and we have

considered extrinsic evidence, viz, Mr. Brower’s expert

testimony.   Respondent neither called any witness to rebut

Mr. Brower nor discredited his testimony by cross-examination.

On brief, respondent attempts to rebut Mr. Brower’s conclusion

that the tribunal could not, within the range of $206,041,000

(the amount stated in section 3 of paragraph 178), have granted
                                 - 59 -


compensation for the undisputed value of the expropriated assets

and have awarded anything in respect of the concession.

Respondent attaches to his brief a table (the table) purporting

to show that the going concern value of Aminoil on the

expropriation date did not exceed $206,041,000.     Respondent

attempts to make that showing by a series of present value

calculations.   There are clear errors of mathematics in the

table, and we fail to understand certain of respondent’s

assumptions.    Also, we agree with petitioner that respondent may

have been too conservative in extending pre-expropriation profits

to post-expropriation years since the tribunal called for a post-

expropriation rate of return “somewhat more liberal” than

appropriate for the pre-expropriation period.

          7.    Conclusion

     The parties agree that the intention of the tribunal governs

as to whether the disputed item is disguised compensation for the

concession or a payment in the nature of interest.     Respondent

argues:

     The ‘inflation’ factor, like the ‘interest’ factor, was
     compensation for the delay in payment, and therefore,
     it is properly treated as ordinary income under section
     61. * * *

                   *         *    *       *     *

     The law is well settled that, amounts awarded for delay
     in payment constitute ordinary income under section 61.
     Kieselbach v. Commissioner, 317 U.S. 399, 402-405
     (1943); Tiefenbrunn v. Commissioner, 74 T.C. 1566
     (1980); Smith v. Commissioner, 59 T.C. 107 (1972).
                              - 60 -


     * * *

Respondent is correct that amounts awarded for delay in payment

in connection with government takings constitute ordinary income.

Petitioner, however, has set forth a plausible interpretation of

the award that contradicts respondent’s assumption that the

tribunal intended by the disputed amount to award Aminoil for a

delay in payment.   Moreover, principally by Mr. Brower's

testimony, petitioner has convinced us that the disputed item is

not compensation for a delay in payment but, rather, is a

disguised payment for Kuwait’s premature termination of the

concession, and we so find.

     D.   Income Tax Consequences

     Although we have found that the disputed amount was intended

by the tribunal as recompense for the concession, that does not

fully resolve the tax consequences attending its receipt.

Petitioner reported the disputed item as an amount realized on

the sale or other disposition of the concession.   Since

petitioner believed that Aminoil’s adjusted basis in the

concession was zero, petitioner reported a gain of $55,147,935.

Petitioner reported that gain as a long-term capital gain under

the authority of section 1231.   Petitioner reported interest of

$41,602,829, which reflected the “reasonable rate of interest,

which could be put at 7.5 percent” provided for in paragraph 178

(the 7.5-percent interest payment).    In support of its claim that
                               - 61 -


the disputed amount was a disguised payment for the concession,

petitioner argues that the 7.5-percent interest payment was a

“sufficient” payment for tax purposes.    Petitioner states that,

if the $179 million payment were regarded simply as an

undifferentiated lump-sum payment for property (“which”,

petitioner argues, “strictly speaking, it is”), “the amount of

interest included in the lump sum would be determined, for tax

purposes, by section 483.”    Petitioner states that the applicable

section 483 rate was 7 percent a year compounded semiannually,

which, petitioner claims, is below the interest rate that gives

rise to the 7.5-percent interest payment.    Thus, petitioner

concludes, “the interest income attributable to the Award’s 7.5%

rate, which petitioners reported in their 1982 return * * * , was

more than sufficient to meet the standard of section 483.”

     Section 483 imputes interest (unstated interest) to a

contract for the sale or exchange of property for which there is

inadequate stated interest.    Section 1.483-1(b)(1), Income Tax

Regs., provides:   “The term ‘sale or exchange’ includes any

transaction treated as a sale or exchange for purposes of the

Code.”   Condemnation proceedings are treated as sales for

Federal income tax purposes.    See Hawaiian Gas Prods., Ltd. v.

Commissioner, 126 F.2d 4 (9th Cir. 1942), affg. 43 B.T.A. 655

(1941); cf. Helvering v. Hammel, 311 U.S. 504 (1941).

Apparently, petitioner accepts that section 483 applies to the
                               - 62 -


$179 million payment.    We believe that petitioner may be mistaken

in concluding that the $179 million payment does not consist of

any unstated interest.   It appears that, in concluding that the

7.5-percent interest payment constitutes an adequate amount of

stated interest, petitioner overlooked the fact that the

7.5 percent interest amount was calculated on the basis of a

principal amount that did not include the disputed item.      The

parties are directed to consult on that point and on the effect

of the various allocations petitioner made (and respondent

accepted) in reporting the award in order to determine whether

there is adequate stated interest.      If the parties can resolve

the unstated interest issue, that resolution shall be reflected

in the Rule 155 calculation.   If the parties cannot resolve that

issue, they shall report that status to the Court so that the

Court may determine the appropriate action.

     Except as may be necessary to reflect unstated interest,

petitioner is sustained in reporting the disputed item as a long-

term capital gain, and respondent’s determination of a deficiency

in tax is not sustained to that extent.


                                            Decision will be entered

                                     under Rule 155.
