                        T.C. Memo. 1997-441



                      UNITED STATES TAX COURT



                 FRANK E. ACIERNO, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 45438-86.           Filed September 25, 1997.



     Declan J. O’Donnell, for petitioner.

     Elizabeth Girafalco Chirich and Marion S. Friedman, for

respondent.


                        MEMORANDUM OPINION


     SWIFT, Judge:   This matter is before us on our order to show

cause why resolution of the issues in this case should not be

controlled by resolution of these same issues in our test case

opinion in Krause v. Commissioner, 99 T.C. 132 (1992), affd. sub

nom. Hildebrand v. Commissioner, 28 F.3d 1024 (10th Cir. 1994).
                                    - 2 -

Krause involved limited partnership investments related to and

similar to those in which petitioner herein invested and which

are at issue in this case.        See also Karlsson v. Commissioner,

T.C. Memo. 1997-432, and Vanderschraaf v. Commissioner, T.C.

Memo. 1997-306, which also involved partnership investments and

issues related to and similar to those in which petitioner herein

invested and which resolved the issues in a manner consistent

with Krause.

       Respondent determined a deficiency in petitioner’s Federal

income tax and additions to tax as follows:


                                              Additions to Tax
                                 Sec.               Sec.          Sec.
Year        Deficiency        6653(a)(1)         6653(a)(2)       6661

1982          $364,452          $18,223              *           $36,445

       * 50 percent of interest due on portion of underpayment
         attributable to negligence.


       Unless otherwise indicated, all section references are to

the Internal Revenue Code, and all Rule references are to the Tax

Court Rules of Practice and Procedure.

       Petitioner invested in Drake Oil Technology Partners

(Drake), a Pennsylvania limited partnership that was part of a

group of tax-oriented limited partnerships with the stated

general objective of, among other things, investing in enhanced

oil recovery (EOR) technology for the recovery of oil and natural

gas.
                               - 3 -

     The primary issues for decisions are:   (1) Whether

activities of Drake were engaged in for profit under section 183;

(2) whether stated debt obligations of Drake constitute genuine

debt obligations giving rise to deductible interest; and

(3) whether petitioner is liable for the additions to tax.

     In the Krause test case opinion, in Vanderschraaf, and in

Karlsson, the first two of the above issues were decided against

the taxpayers, and the third issue was decided against

respondent.

     This Court uses show cause procedures in situations similar

to the instant case where the disposition of the pending case may

be affected by a previously decided test case.   See Lombardo v.

Commissioner, 99 T.C. 342, 343-345 (1992), affd. sub nom. Davies

v. Commissioner, 68 F.3d 1129 (9th Cir. 1995); Gray v.

Commissioner, T.C. Memo. 1996-525; Finkelman v. Commissioner,

T.C. Memo. 1994-158; Iowa Investors Baker v. Commissioner, T.C.

Memo. 1992-490; Bokum v. Commissioner, T.C. Memo. 1990-21, affd.

992 F.2d 1136 (11th Cir. 1993).


Background

     Many of the relevant facts have been stipulated and are so

found.   The entire trial record and the testimony and exhibits

admitted into evidence in our test case opinion in Krause v.

Commissioner, supra at 133-167, have been stipulated as part of

the trial record herein.   As stated, Krause involved limited
                              - 4 -

partnership investments that are closely related to the limited

partnership investment at issue herein.

     Background and other general facts as they were found in

Krause that relate directly and indirectly to the partnership

investments involved herein we, by this reference, incorporate as

findings of fact in the instant case.

     At the time his petition was filed, petitioner resided in

Greenville, Delaware.

     Of the total $75,909,492 cumulative losses reported by Drake

on its Federal partnership income tax returns for 1981 through

1984 and passed through to the limited partners of Drake,

$72,620,000 related to the EOR license fees purportedly owed by

Drake.

     In Krause v. Commissioner, supra, we analyzed in detail the

various EOR technology license and lease agreements and the

purported partnership debt obligations relating thereto that were

entered into by various of the limited partnerships (specifically

including Barton Enhanced Oil Production Income Fund (Barton),

which is closely related to Drake), and we analyzed the state of

development of the specific EOR technology involved in the

partnership license agreements.

     With regard to the excessive nature of the EOR technology

license agreements, we concluded in Krause that --


     The stated consideration agreed to by the partnerships
     for the license of EOR technology * * * bore no
                              - 5 -

     relation to the value of that which was acquired, did
     not conform to industry norms, and precluded any
     realistic opportunity for profit.

     the estimates used by the partnerships for projected
     oil recovery from the use and application of the EOR
     technology licensed by the partnerships are not
     supported by credible expert testimony in this case and
     were not reasonable. [Id. at 169; citations omitted.]


     With regard to the lack of development of the EOR

technology, we stated in Krause that the --


     portfolio [of EOR technology] consisted of a package of
     vague, largely untested ideas, that, if and to the
     extent ever developed, would likely be available
     generally in the marketplace and on much more favorable
     terms than from the partnerships. We reject
     petitioners' argument that the portfolio of EOR
     technology obtained by the partnerships represented
     anything of any substantial value. The EOR technology
     license agreements entered into * * * were essentially
     valueless. [Krause v. Commissioner, 99 T.C. at 175.]


     With regard to the lack of validity of the debt obligations

of the partnerships, we stated in Krause that --


          The multimillion dollar license fees and royalties
     * * * were excessive. They did not reflect arm's-
     length obligations, and they are not to be recognized
     as legitimate obligations of the partnerships. The
     debt obligations of the partnerships associated
     therewith did not constitute genuine debt obligations
     and are to be disregarded. [Id.; citations omitted.]


     In summary, in Krause, among other things, we concluded that

the partnerships, the various license and lease agreements, the

EOR technology, and the purported debt obligations of the
                               - 6 -

partnerships constituted nothing more than an elaborate tax

shelter scheme, as follows:


          In summary, presented to us in this case is a
     chain or multilayered series of obligations, stacked or
     multiplied on top of each other via the numerous
     partnerships to produce debt obligations in staggering
     dollar amounts, using a largely undeveloped and
     untested product, in a highly risky, very speculative,
     and nonarm's-length manner in an attempt to generate
     significant tax deductions for investors. The
     transactions did not, and do not, constitute legitimate
     for-profit business transactions. [Id. at 175-176.]

     On the basis of our findings and opinion in Krause, the

affirmance thereof by the U.S. Court of Appeals for the Tenth

Circuit, and the denial of certiorari by the U.S. Supreme Court,

thousands of investors who had invested in Barton and in other

related limited partnerships, including Drake, settled their

Federal income tax liabilities with respondent relating to these

investments.   Petitioner herein and respondent, however, have not

been able to reach a settlement agreement, and petitioner alleges

the existence of material facts that he believes distinguish his

limited partnership investment in Drake from the investments that

were made by the taxpayers in Barton and that were specifically

addressed in Krause.

     We issued a show cause order, and we held an evidentiary

hearing in connection with our show cause order to give

petitioner an opportunity to establish how, for Federal income

tax purposes, his limited partnership investment in Drake and the

activities of Drake were distinguishable from the limited
                               - 7 -

partnership investments in, and the activities of, Barton as

described and as found in Krause.

     On the basis of the evidence admitted at the hearing on the

show cause order and for the reasons stated below, we conclude

that, for Federal income tax purposes, petitioner’s limited

partnership investment in Drake, the activities of Drake, and the

purported debt obligations of Drake are not distinguishable from

the investments in, the activities of, and the purported debt

obligations of Barton as described in the Krause opinion.

Discussion

     In late 1978 or 1979, Winsor Savery, Richard B. Basile, E.

Barger Miller, Werner Heim, Robert Shaftan, William Conklin, and

other tax shelter promoters who had no significant experience

with oil and gas investments began forming tax shelter limited

partnerships (including Drake and Barton) with the stated general

investment objectives of drilling for oil and natural gas and of

obtaining the rights to certain EOR technology that might be

developed and become valuable if oil prices continued to rise

dramatically in subsequent years.

     Partnerships were formed each year from 1979 through 1984,

with slight differences in general partners, structure,

properties, and activities depending on the year the partnerships

were formed.   Drake was formed as a 1981 Denver partnership with

Louis Coppage as the individual general partner.   Barton was

formed as a 1982 Wichita partnership with Gary Krause as the
                                    - 8 -

individual general partner.    As stated, Barton was involved

directly in the Krause case.

     All of the 1979 and 1980 partnerships invested in the Monroe

gas field in Texas and leased tar sands acreage in Utah.       The

1981 and 1982 partnerships, including Drake and Barton, did not

invest in the Monroe gas field, nor in the tar sands acreage.

     All of the 1981 and 1982 partnerships undertook various oil

and gas activities in fields such as the Illinois Basin, Castaic

Hills, and elsewhere, the activities of which were not challenged

by respondent.     In spite of such other activities, however, we

still found in Krause v. Commissioner, supra at 150-157, that

Barton's activities were not engaged in with an actual and honest

profit objective and that its EOR technology license fees were

excessive, did not reflect arm's-length obligations, and were not

to be recognized as legitimate debt obligations of Barton.       See

id. at 169, 175.

     There were 363.1 limited partnership units in Drake sold to

270 limited partners.     By 1982, Drake had 275 limited partners.

     The total stated subscription price for each limited

partnership unit in Drake was $150,000, payable by each limited

partner as follows:


      Cash             Promissory Note              Due Date

     $12,500                 ---                On subscription
       ---                $12,500               April 15, 1982
       ---                 12,500               April 15, 1983
                              - 9 -

The $112,500 balance (including simple interest at 7 percent per

year) of each limited partner’s $150,000 total subscription fee

per partnership unit was deferred and was stated to be due in

approximately 15 years (namely, in 1994, 1995, and 1996).

     On the basis of the number of limited partnership units in

Drake that were sold, the investors in Drake owed Drake the

following stated total amounts:


     Cash & Short-Term            Purported Recourse
     Debt Due In First        Long-Term Debt Obligations
          3 Years                  Due In 1994-1996

        $13,616,000                   $40,849,000


     In spite of the large short- and long-term debt obligations

nominally associated with investments in Drake, no credit

investigations were undertaken by Drake with regard to the

creditworthiness of the limited partners who invested in Drake.

     On December 29, 1981, petitioner subscribed to 10

partnership units in Drake, and petitioner executed in connection

therewith one promissory note to Drake in the stated principal

amount of $12,500 due on April 15, 1982, and another promissory

note to Drake in the stated principal amount of $25,000 due on

December 15, 1983.

     Petitioner did not have any oil or gas experience, did not

conduct any outside investigation of any persons, entities, or

properties mentioned in Drake's offering memorandum, and did not

hire an expert to evaluate the investment.   Petitioner did not
                                - 10 -

investigate the underlying facts, assumptions, opinions, or tax

treatment of deductions presented in the offering memoranda.

Petitioner relied solely on his accountant, who recommended to

him the investment in Drake.     Petitioner was aware that his

accountant received commissions from Drake based on the number of

investors referred to Drake who purchased partnership units in

Drake.

     The evidence does not establish that petitioner made the

full principal and interest payments due in 1982 and 1983, and

petitioner did not make payments on the stated debt obligations

due in 1994 and 1995 relating to his purchase of limited

partnership units in Drake.

     Petitioner alleges many material differences between Drake

and Barton.    Respondent counters that no material differences

between Drake and Barton have been established and that the

Court’s holding in Krause v. Commissioner, 99 T.C. 132 (1992),

should apply to resolution of the issues before us in this case.

     Petitioner has not credibly explained or established, either

at the show cause hearing or in his briefs, why any of the

alleged factual differences between Drake and Barton would be

material.     Some of the alleged differences are minute and

pointless.     Petitioner ignores the similarities between Drake and

Barton, which are controlling.

     As explained, the stated business objective of Drake, per

its offering memorandum, was to acquire producing oil wells and
                               - 11 -

to apply EOR technology to the production of oil from the wells.

Drake, like Barton, did not participate in any transactions

involving the lease of tar sands properties from TexOil

International Corp. nor the lease of natural gas properties in

the Monroe gas field in Louisiana.      See id. at 150-157.

     Drake and the related partnerships, as described in detail

in Krause v. Commissioner, supra at 140-143, 152-157, entered

into license agreements either with Elektra Energy Corp.

(Elektra) or with Hemisphere Licensing Corp. (Hemisphere) to

obtain limited rights to use certain purported EOR technology in

the production of oil.

     General explanatory material relating to the oil crisis of

the late 1970's and early 1980's and a detailed explanation of

the EOR technology involved herein are set forth in Krause and

will not be repeated herein.   See id. at 134-136, 157-165.

     The EOR technology licensed by Drake constituted essentially

the same EOR technology as that licensed to many of the other

related partnerships, including Barton and other partnerships

involved in the Krause test case.    Id. at 157-165.

     Under the EOR license agreement that was entered into

between Drake and Hemisphere, Drake nominally agreed to pay fixed

license fees to Hemisphere of $50,000 per partnership unit per

year for 5 years.

     Drake’s annual $50,000 per partnership unit technology

license fee to Hemisphere was to be paid, during each of the 5
                               - 12 -

years it was nominally due, through the following combination of

cash and partnership promissory notes:


                            Per Partnership Unit
                                       Partnership
             Year         Cash      Promissory Note

               1      $3,500             $ 46,500
               2       2,800               47,200
               3       2,000               48,000
               4        -0-                50,000
               5        -0-                50,000


     Drake’s purported debt obligations to Hemisphere with regard

to the above technology license fees were never reduced to

written promissory notes.

     By executing the subscription agreements with regard to

their investments in Drake, each limited partner of Drake

purported to assume personal liability on Drake’s stated debt

obligations to Hemisphere under the technology license agreement

to the extent of the unpaid portion of each limited partner’s

per-unit stated $112,500 deferred capital contribution obligation

to Drake.

     Other related partnerships, under similar license agreements

of the same EOR technology, agreed to stated debt obligations to

Hemisphere in total stated principal amounts ranging from $7.2

million to $87.7 million, and the total principal amount in each

case depended on the number of limited partnership units that

were sold to investors.
                             - 13 -

     Total fixed EOR license fees agreed to by the five so-called

Denver-1981 partnerships and the two Denver-1982 partnerships

(groups of particularly related limited partnerships which

included Drake) totaled $310,214,500.

     Hemisphere, however, had obtained rights to use and license

the same EOR technology that it had licensed to Drake for running

royalties based on actual incremental increased recovery of oil

attributable to use of the technology.   Hemisphere was obligated

to pay no fixed license fees for the EOR technology.

     Of the total cash contributions received from limited

partners by the five Denver-1981 partnerships (including Drake),

excessive amounts were paid to various promoters, lawyers,

accountants, and salesmen, and little was available for

development of EOR technology.   Expenses paid apparently relating

just to formation and organization of the five Denver-1981

partnerships including Drake totaled $552,468.

     In his capacity as general partner of various related

partnerships, Coppage received approximately $2,061,925, of which

$272,325 was received from Drake.   Coppage's wholly owned

corporation, related entities, and employees thereof directly or

indirectly received at least an additional $504,443.

     Various salesmen received a total of $4,143,515 in

connection with the sale of limited partnership units in the five

Denver-1981 partnerships.
                             - 14 -

     A law firm named Somers & Altenbach received $583,555

for purported legal services and for agreeing to defend, in

subsequent years, tax benefits that were to be claimed in

connection with the Denver-1981 partnership investments.

The fee of Somers & Altenbach was based on 1-percentage point of

total funds raised by the five Denver-1981 partnerships.

     Many of the legal, economic, and technical opinions obtained

by Drake and the other related partnerships relied on unrealistic

and unreliable representations made by individuals who invested

in the partnerships, who were involved in promoting the

partnerships, and who received fees from the partnerships based

on the number of limited partnership units sold.

     Petitioner alleges that Drake's lack of participation in the

TexOil tar sands acreage leased to the earlier 1979 and 1980

partnerships is not comparable with investments Drake (and the

other Denver partnerships) allegedly made in later years in

other, unrelated tar sands acreage in Utah.   There is no credible

evidence as to how an investment in other tar sands properties

might justify the EOR license fees.   Petitioner’s expert, Thomas

Logan, provided no explanation in this regard.   There existed no

proven reserves in the various tar sands properties and no proven

methods for recovering commercial quantities of oil from the tar

sands.
                             - 15 -

     Petitioner attempts to distinguish Drake because Drake

invested in oil wells located in the Illinois Basin.   Barton,

however, which was involved in our test case, Krause v.

Commissioner, 99 T.C. 132 (1992), also invested in oil wells

located in the Illinois Basin.    Drake's activity in the Illinois

Basin and elsewhere in no way justifies the EOR license fees to

which Drake agreed.

     Drake realized income from oil and gas activities in the

Illinois Basin equivalent to less than 1 percent of the license

fees accrued (without regard to interest).   Drake's activities in

other oil and gas fields yielded even less income.

     In 1983, the best year for the Illinois Basin joint venture

in which Drake participated with other partnerships, revenue from

oil and gas sales totaled $3,243,148.   After expenses, Drake was

allocated $309,776 of these sales proceeds, less than 2 percent

of the license fees Drake owed.

     Petitioner alleges that Coppage, Drake’s individual managing

general partner, was not among the original creators of this tax

shelter partnership and that he was not tainted by many of the

non-arm’s-length features of the partnerships.   To the contrary,

the evidence is clear that Coppage entered into the license

agreements on behalf of Drake without negotiating the price.

There is no credible evidence that Coppage relied on anyone
                               - 16 -

independent of the shelter promoters in making decisions

regarding Drake’s initial operations and financial commitments.

     Coppage did retain a lawyer, Renno L. Peterson, to review

Drake's offering memorandum.   Peterson expressed criticism about

significant aspects of the Drake partnership, but the changes

Peterson recommended were not implemented.

     Petitioner alleges differences in the license agreements

between the Drake and Barton partnerships, on the one hand, and a

number of the other partnerships, on the other hand.    Petitioner

incorrectly alleges that, under their EOR license agreement,

Drake and Barton had the right to use the technology in a

commercial project but that the other partnerships did not have

such right.   All partnerships, however, had the right to use the

EOR technology in a commercial project.   Drake and Barton had a

single technology license agreement permitting both testing and

commercialization, whereas many of the other partnerships had one

license that allowed use of the technology only for testing and

another separate license for a commercial project.   No evidence

indicates that this difference in format is material.   Under

either license format, use of the technology on a commercial

project was permitted, but the fixed license fees were based on

the number of partnership units sold, and under both license

formats, the partnerships would be obligated to pay additional
                               - 17 -

royalties if any actual production resulted from use of the

licensed EOR technology.

       Other differences alleged by petitioner have no

significance.

       All of the partnerships, including Drake and Barton, were

organized around similar stated fixed license fees that were

based on a portfolio of technology, the total amount of which was

based on the number of partnership units sold.    The licensed

technology was either merely conceptual or could have been

obtained with no fixed fees.    Krause v. Commissioner, supra at

158-163.

       The stated consideration that Drake agreed to pay for the

licenses was excessive, did not bear any relationship to what was

acquired, and was designed to generate deductions that would

produce losses for the investors far in excess of what they

contributed in cash to the partnerships.    Neither Basile,

Coppage, nor Krause independently investigated or attempted to

determine the fair market value of the licenses.    Id. at 146,

155.

       At the time the partnerships obtained licenses of EOR

technology, the partnerships had no idea what technology they

might need or whether the technology they had licensed would, or

even could, be utilized.    This is true for all of the

partnerships, whether they had leased acreage in the Utah tar
                              - 18 -

sands, like Technology-1980, id. at 143, had no rights to acquire

any oil and gas properties at all, like Barton, id. at 151, or

had options on the Parker Field oil field, like Drake.

     Drake’s license of a portfolio of EOR technology with

exorbitant fixed fees and with no knowledge of whether the

technology would be needed, or would even work, was not

consistent with industry standards.    Id. at 140, 169.   What Drake

did after it licensed the technology does not overcome the

defects present with the original EOR technology license -- the

licensing of EOR technology for grossly exorbitant fees that

establish that the investment was a tax shelter and that the

partnerships lacked a profit objective.

     Petitioner alleges that certain findings made in the Krause

opinion are erroneous.   The evidence produced at the show cause

hearing, however, does not raise any credible doubt as to the

correctness of the Krause findings of fact.

     For example, petitioner challenges the Krause finding that,

in the oil industry, license fees for use of EOR technology were

customarily based only on incremental increased production

attributable to the technology.   No evidence, however, was

produced at the show cause hearing to support this claim.

     Petitioner alleges that Drake’s attempted reorganization in

1987 would support a finding that Drake was significantly

different from Barton.   The partnerships involved in the Krause
                              - 19 -

test case, however, also reorganized in a manner similar to

Drake’s reorganization.   In 1986, the partnerships involved in

Krause, including Barton, amended their EOR technology license

with Hemisphere and significantly reduced the annual license fee

owed.   Krause v. Commissioner, supra at 157.   Petitioner’s

attempt to distinguish Drake from the Krause partnerships is

completely unsupported by the evidence.

     Petitioner cites a number of cases and appears to argue that

his investment in Drake is, on legal grounds, distinguishable

from the partnerships involved in Krause.   Petitioner’s case

authority is miscited and in no way supports petitioner’s

position herein.   See also Karlsson v. Commissioner, T.C. Memo.

1997-432; Vanderschraaf v. Commissioner, T.C. Memo. 1997-306.

     Drake shares the same controlling characteristics as Barton

and the other partnerships involved in the Krause opinion.      No

credible, material differences have been established, and no

persuasive arguments have been presented that distinguish Drake

from the Krause test case partnerships.

     In light of our resolution of the above issues (namely, the

lack of profit objective of Drake and the nongenuine nature of

Drake’s debt obligations) on the bases explained, other arguments

made by respondent with regard to the disallowance of Drake’s

claimed losses and credits need not be addressed.
                             - 20 -

     Turning to the additions to tax, our analyses in the related

Krause, Karlsson, and Vanderschraaf opinions, on general terms,

of the additions to tax at issue provide adequate support for our

decision herein not to sustain respondent’s determinations as to

the sections 6653(a)(1) and (2) and 6661 additions to tax.   We so

hold.



                                        An appropriate order

                                   and decision will be entered.
