                         T.C. Memo. 1997-571



                       UNITED STATES TAX COURT



                     RESTORE, INC., Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8508-96.                 Filed December 29, 1997.



     Glen A. Stankee, for petitioner.

     Sergio Garcia-Pages, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:    Respondent determined deficiencies in

petitioner's Federal income taxes and accuracy-related penalties

as follows:

                                        Accuracy-related Penalty
      Year            Deficiency              Sec. 6662(a)

      1991             $81,451                   $16,290
      1992             714,424                   142,885
      1993             477,936                    95,587
                               - 2 -


     After concessions, the issues for decision are:    (1) Whether

petitioner may accrue and deduct royalties computed but not yet

paid under an agreement with Matrix, a foreign corporation which

owns 70 percent of petitioner; (2) whether petitioner may deduct

interest accruals allegedly owed to Matrix on the unpaid

royalties; and (3) whether petitioner is liable for accuracy-

related penalties pursuant to section 6662(a).1


                          FINDINGS OF FACT


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

The stipulation of facts and the second stipulation of facts are

incorporated herein by this reference.

     Petitioner, a Florida corporation with its principal office

in Fort Lauderdale, filed its Form 1120, U.S. Corporation Income

Tax Return, on a calendar year basis.    Petitioner reported its

income and kept its books using the accrual method of accounting

for each year in issue.   Petitioner's principal product is named

"Restore", an automobile engine additive sold in many stores

throughout the United States, Canada, and the Caribbean.    The

essential ingredient in the engine additive is a specially

developed metal alloy (alloy) in powdered form which, when mixed


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 3 -

with oil and added to the crankcase of an operating engine, is

supposed to increase engine compression, power, and efficiency in

older cars.    The alloy is manufactured and added to the oil, and

transferred to petitioner through a group of related entities

with which petitioner is affiliated.

     The formula and process by which the alloy is manufactured

was developed by a member of the Sultan family.    Mr. Omar Sultan,

a U.S. citizen and a member of the Sultan family, sought to

market the alloy.    In 1982, purely by chance, Mr. Sultan met Mr.

Ramzi Toufic Fares on a train in Germany where the two men

discussed the uses of the alloy.    Mr. Fares had experience in

project development, investment banking, management, and raising

investment capital.    As a result of the chance meeting, Mr.

Sultan and Mr. Fares developed a plan whereby they would form a

group of corporations through which they would market the alloy.

     In furtherance of their common goal, Mr. Fares and Mr.

Sultan caused the formation of Matrix Metal Corp. (Matrix) under

the laws of the Republic of Panama on January 13, 1983.    Under

its articles of incorporation, Matrix had authorized capital of

$5 million divided into 5,000 shares with a par value of $1,000

per share.    The first directors of Matrix were listed as Mr.

Fares, Mr. Sultan and Dr. Samir Klat, and the first officers were

Mr. Fares (president and treasurer) and Mr. Sultan (secretary).

The principal activity of Matrix was to act as a holding company
                               - 4 -

for subsidiary companies involved in the production,

conditioning, and marketing of the alloy.

     On February 11, 1983, Matrix entered into an agreement known

as the "Heads of Agreement" with Mr. Edwin J. Werner, Mr. Richard

Rynkiewicz, and Mr. John C. Davidson, Jr., who became

shareholders in an S corporation known as WRD, Inc.2    The Heads

of Agreement contained, among other things, a provision that

required Matrix and WRD, Inc., jointly to form a company named

"Restore Corporation" (later known as petitioner).     Petitioner's

main purpose was to market Matrix's products in North America and

the Caribbean.   Paragraph 6 of the Heads of Agreement required

that petitioner would be owned 70 percent by Matrix and 30

percent by the partners of WRD, Inc.    Paragraph 12 of the Heads

of Agreement states that "RESTORE shall pay MATRIX a royalty fee

equivalent to 10 (ten) percent of RESTORE'S net sales, in return

for the exclusive rights granted by MATRIX to RESTORE."

     On February 23, 1983, articles of incorporation for

petitioner (Restore Incorporated) were filed with the State of

Florida.   The articles of incorporation listed the following

officers and directors of petitioner:   Mr. Werner (president),

Mr. Rynkiewicz (secretary/treasurer), Mr. Davidson (vice

     2
      At the time of the execution of the Heads of Agreement in
1983, Messrs. Werner, Rynkiewicz, and Davidson were in the
process of forming an S corporation with Mr. Ronald C. Dugan and
Mr. Joe Quinlan known as WRD, Inc. However, in the Heads of
Agreement, WRD, Inc., was referred to as "the Corporation." WRD,
Inc., was organized under the laws of the State of Florida.
                               - 5 -

president), Mr. Fares (vice president), and Mr. Sultan (vice

president).

     On February 24, 1983, petitioner's first meeting of the

board of directors was held and the following persons were

elected as officers:   Mr. Werner (president); Messrs. Davidson,

Fares, and Sultan (vice presidents); and Mr. Rynkiewicz

(secretary and treasurer).   Each of the above-listed persons was

also elected as a director of petitioner.   Petitioner's shares of

common stock were issued to Matrix and WRD, Inc.   Fourteen shares

(70 percent) were issued to Matrix and six shares (30 percent)

were issued to WRD, Inc.

     On March 16, 1983, Matrix and WRD, Inc., entered into a

second agreement, which superseded and replaced the Heads of

Agreement and was known as the "Joint Venture Agreement" (JV

agreement).   The JV agreement contained provisions similar to

those contained in the February 11, 1983, Heads of Agreement.

The JV agreement provided, among other things, that Matrix and

WRD, Inc., would jointly form a corporation named Restore

Incorporated (petitioner).   Petitioner's primary purpose was to

market the products of Matrix "according to terms and conditions

to be set out in an agreement between MMC and RESTORE

(hereinafter referred to as the "Marketing Agreement")."3    Again,

     3
      Under the JV agreement, Matrix Metal Corporation is
referred to as "MMC". By Mar. 16, 1983, petitioner was already
formed as a corporation under the laws of Florida. Petitioner
                                                   (continued...)
                                - 6 -

the parties agreed that Matrix would own 70 percent of petitioner

and WRD, Inc., would own 30 percent of petitioner.   Paragraph 11

of the JV agreement states "RESTORE shall pay MMC a royalty fee

equivalent to 10 (ten) percent of RESTORE's net sales, in return

for the exclusive rights to be granted by MMC to RESTORE as set

forth in the Marketing Agreement.   Net sales shall be defined as

total gross sales less returns."    The JV agreement provided that

Mr. Sultan shall be the chairman of the board and Mr. Werner

shall be the president and the chief executive officer of

petitioner.   The agreement was signed by Mr. Fares as the

president of Matrix and by Mr. Werner as president of WRD, Inc.

     On April 5, 1983, Matrix entered into an agreement with

petitioner known as the "Marketing Agreement".   Among other

things, the Marketing agreement provided that petitioner, as

Matrix's exclusive representative in North America and the

Caribbean, would market and sell Matrix's product consisting

primarily of the alloy in its finished form.   Paragraph 6 of the

Marketing agreement provided:


     In return for the exclusivity granted by MMC [Matrix]
     to RESTORE under the provisions of this Agreement,
     RESTORE shall pay MMC a royalty fee of 10 (ten) percent
     of RESTORE's net sales. Net sales shall be defined as
     total billed gross sales less the value of any products
     returned by customers and less the trade cash discount
     of 2%.

     3
      (...continued)
continued to file its Federal income tax returns as a U.S.
corporation.
                                 - 7 -


Paragraph 18 of the Marketing agreement stated:


     This Agreement shall be initially valid for a period of
     5 (five years) from the date of its signing by the last
     of the two Parties. Unless terminated in accordance
     with the provision of paragraph 19 (nineteen) below, it
     shall be automatically renewed thereafter on a year by
     year basis.[4]


The Marketing agreement was signed by Mr. Fares as president of

Matrix and by Mr. Werner as president of petitioner.

     At the time the Marketing agreement was signed, petitioner

began incurring expenses, building inventory, and accruing

receivables.   Petitioner also began accruing royalties owed to

Matrix under the terms of the Marketing agreement.    Petitioner,

however, has never paid any of the accrued royalties to Matrix.

     Prior to Matrix's first shareholders' meeting in April of

1984, Matrix estimated that by August of 1985 petitioner would

have positive cash-flow.     Also, the shareholders of Matrix agreed

that although Matrix expected to accrue over $2 million in

royalties from petitioner by August 1985, Matrix would cause the

royalties to be retained by petitioner until petitioner's cash-


     4
      Paragraph 19 states:


     This Agreement may be terminated by either Party at any
     time during its validity in case of breach of any of
     its provisions by the other Party and failure to
     correct the breach within 30 (thirty) days from
     notification to that effect by the complaining Party to
     the breaching Party.
                               - 8 -

flow became positive or until its financial performance allowed

it to obtain credit at agreeable terms from a U.S. financial

institution.   On December 17, 1984, Mr. Fares and Mr. Werner

signed a document entitled "Addendum No. 1" (addendum) to the

Marketing agreement.   The addendum adds to paragraph 6 of the

Marketing agreement and states in part:


     1.   Royalty fees accruing since inception, until 31st
          December, 1984, will be payable on the 31st
          January, 1985.

     2.   As of 1st January, 1985, royalty fees will be
          payable based on the net sales realised [sic] each
          quarter, and will become due one month after the
          end of each quarter, the first time on 30th April,
          1985, on the basis of the first quarter's sales.

     3.   In consideration of the financial situation and
          the cash position of RESTORE INC., the parties may
          agree on postponement of payment to a mutually
          agreeable later date. However, in such
          circumstances, the amounts due will bear interest
          from the due date, until the time of payment, at
          the rate of 2% p.a. (two percent per annum) over
          the U.S. prime rate. The applicable rate will be
          the rate published on the first banking day of
          each quarter, with validity for the full quarter.

     This addendum forms an integral part of the above
     [Marketing] Agreement.


The addendum was signed by Mr. Fares as president of Matrix and

by Mr. Werner as president of petitioner.   For the tax year

ending December 31, 1985, petitioner accrued, expensed on its

books, and deducted for tax purposes, interest payable to Matrix

on the accrued royalties at an interest rate of prime plus two

percent. Petitioner never paid Matrix the accrued interest.     As a
                                - 9 -

result of the accrual of interest payable by petitioner, Matrix

recorded interest receivable from petitioner and a corresponding

amount of income.

       Beginning in 1983, petitioner reported a net loss on its

Form 1120, and continued to report losses until the year ending

December 31, 1988.    In the years ending December 31, 1989 and

1992, petitioner reported positive taxable income before taking a

deduction for net operating losses from prior years.      In 1990,

1991, and 1993 through 1995, petitioner reported net losses.

Petitioner reported no tax due and paid no taxes in all the years

1983 through 1995.    Petitioner's accrued royalties and interest

due on the accrued royalties to Matrix as of December 31, 1994,

were    $6,186,961 and $1,417,697, respectively.    Throughout this

time period, petitioner continued to accrue, deduct, but not pay,

royalties and interest related to the accrued royalties.


                               OPINION


       The first issue we must decide is whether petitioner may

accrue and deduct royalties computed but not yet paid under an

agreement with Matrix.    Respondent argues that petitioner is not

entitled to deduct the accrued royalties at issue because

petitioner's liability to pay the accrued royalties was subject

to the contingency that profits must first be realized before

petitioner was to pay the accruals.      Petitioner's position is

that it may deduct the accrued royalties because the liability to
                              - 10 -

pay the accrued royalties was established during each year in

which they were accrued and only the time of payment was

contingent.

     The standard for determining whether an accrual basis

taxpayer has incurred a deductible expense for Federal income tax

purposes is governed by the "all events test."   See United States

v. General Dynamics Corp., 481 U.S. 239, 242 (1987); United

States v. Hughes Properties, Inc., 476 U.S. 593, 600-601 (1986);

Putoma Corp. v. Commissioner, 601 F.2d 734, 738 (5th Cir. 1979),

affg. 66 T.C. 652 (1976).   Under the Regulations, the "all

events" test has two elements, each of which must be satisfied

before accrual of an expense is proper.   First, all the events

which establish the fact of the liability must have occurred.

Second, the amount must be capable of being determined "with

reasonable accuracy."   United States v. Hughes Properties, Inc.,

supra at 600; sec. 1.446-1(c)(1)(ii), Income Tax Regs.5




     5
      In the Deficit Reduction Act of 1984, Congress incorporated
the "all events" test into the Internal Revenue Code by adding a
new sec. 461(h). Pub. L. 98-369, sec. 91(a), 98 Stat. 598, 607.
Sec. 461(h)(4) provides that the "all events test" is met "with
respect to any item if all events have occurred which determine
the fact of liability and the amount of such liability can be
determined with reasonable accuracy." Sec. 461(h)(1) limits the
applicability of the test by providing that it is not met until
"economic performance" occurs. See United States v. General
Dynamics Corp., 481 U.S. 239, 243 n.3 (1987). In light of our
conclusion, infra, that petitioner has failed to satisfy the "all
events" test, we need not consider the applicability of the
economic performance requirement.
                               - 11 -

     With respect to the first requirement of the all events

test, the accrual of an item of expense is improper where the

liability for such item is contingent upon the occurrence of a

future event.6    See Security Flour Mills Co. v. Commissioner, 321

U.S. 281 (1944); Brown v. Helvering, 291 U.S. 193, 200 (1934)

(except as otherwise specifically provided by statute, a

liability does not accrue as long as it remains contingent);

Putoma Corp. v. Commissioner, supra at 739.

     Paragraph 6 of the Marketing agreement requires petitioner

to "pay MMC a royalty fee of 10 (ten) percent of RESTORE's net

sales."   The agreement between petitioner and Matrix, as written,

does not reveal any contingency upon which the parties appear to

have conditioned petitioner's liability.    However, respondent

argues that it was Matrix's and petitioner's intention that the

payment of the royalties be contingent on reaching an unspecified

level of profits.

     On April 12 and 13, 1984, the shareholders of Matrix had

their first annual meeting.    The report of the shareholder

meeting states:


     Although until that date [August 1985] MMC is
     expected to have earned over U.S. $2 million from
     RESTORE INC. in royalties, we have agreed to
     retain such royalties within RESTORE as

     6
      Respondent does not contend that the accrued royalties
could not be determined with reasonable accuracy. Moreover, the
amounts accrued are ascertainable by the formula agreed to in the
Marketing agreement.
                            - 12 -

     shareholders' subordinated loans until such time
     when RESTORE's cash flow will become positive, or
     its market and financial performance will have
     enabled it to negotiate easier terms from the
     same, or another bank in the U.S.A. [Emphasis
     added.]


Witnesses presented at trial by both petitioner and respondent

confirmed that the parties intended that petitioner never

actually pay the royalty to Matrix until petitioner's financial

performance reached an unspecified level.7   Mr. Werner,

petitioner's president, testified that from the beginning, when

the agreement was first signed, the likelihood of petitioner's

making any significant profit was remote and that petitioner

would pay the royalties to Matrix as soon as the company began

developing a profit.   Mr. Dugan, who succeeded Mr. Werner as

petitioner's president, testified it was his understanding that

petitioner would not pay the accrued royalties until it began to

show a profit.   Mr. Fares, who along with Mr. Sultan founded

petitioner, testified that the royalties would only be paid to

Matrix when petitioner was profitable and that it was envisioned

from the beginning that petitioner would not be profitable for a

number of years.   As of the date of trial, petitioner had not

made any royalty payments to Matrix.


     7
      Although Mr. Sultan, a director, officer, and shareholder
of Matrix, testified there was no specific agreement that
petitioner did not have to pay royalties until it achieved
certain goals, we find that in fact there was such an intention
in the Marketing agreement.
                                - 13 -

     It is unclear from the record how many contingencies needed

to be satisfied before petitioner was required to pay the accrued

royalties to Matrix.   According to the report of the shareholders

meeting, petitioner had to have either positive cash-flow or

financial performance which would enable it to obtain financing

from a U.S. bank before the payments were to be made.    Added to

these contingencies is a third and fourth contingency that

petitioner be sufficiently profitable and have sufficient working

capital to meet other financial obligations.    Petitioner does not

dispute that payment of the royalties was contingent upon:    (1)

Achieving goals set for petitioner, and (2) obtaining sufficient

working capital and whatever cash reserves it needed to meet

other financial obligations.8    We find that the nonpayment of the

royalties, which have accrued since 1983, the testimony of all

parties involved, and the minutes of Matrix's shareholder

agreement are determinative of the fact that the royalty payments

were contingent from the inception of the Marketing agreement.

     In order to find that there is a contingency such that "all

the events" creating the liability have not occurred in the


     8
      Respondent, in a request for confirmation of answers to
questions posed to petitioner in a discovery conference, asked
petitioner to confirm, among other things, the following
question: "What criteria would Omar Sultan use to decide when
Restore, Inc. should start paying the royalties to Matrix?"
Petitioner answered by stating: "The royalties would be paid
when the goals of the joint venture were achieved, provided it
had sufficient working capital and whatever cash reserves it
would require to meet its obligations."
                              - 14 -

taxable year, there must be a contingency as to the fact of the

liability itself.   See United States v. Hughes Properties, Inc.,

supra at 601-603 (payment not contingent where the fact of the

liability was fixed by State law); Mooney Aircraft, Inc. v.

United States, 420 F.2d 400, 406 (5th Cir. 1969).   A contingency

related only to the timing of the required payment will not

prevent a taxpayer from satisfying the all events test.     United

States v. Hughes Properties, supra at 604.   Therefore, we must

decide whether the contingencies that had to be met in this case

concern whether petitioner would ever be liable to pay the

royalties and interest.

     Petitioner argues that its obligation to pay the accrued

royalties was fixed and definite.   Respondent cites two cases

which support the disallowance of accruals where the underlying

liability is contingent on the taxpayer's profitability or cash

reserves.   Respondent cites Putoma Corp. v. Commissioner, 601

F.2d at 739, wherein two corporate accrual taxpayers were not

entitled to deductions for accrued bonuses where payment was

conditioned under the terms of the agreement on the "judgment of

the majority of the directors of the company, [that] the company

has sufficient cash reserve in order to pay the salary."

Respondent also cites Burlington-Rock Island R.R. v. United

States, 321 F.2d 817, 818 (1963), wherein deductions were

disallowed for interest accrued under an agreement conditionally

obligating the taxpayer to make interest payments "from time to
                             - 15 -

time, insofar as its cash situation will reasonably permit."        We

agree with respondent and find both cases to be on point.

     We find no meaningful distinction between the contingencies

in Putoma Corp. v Commissioner, supra, and Burlington-Rock Island

R.R. v. United States, supra, and the contingencies that must be

satisfied prior to payment of the accrued royalties.    There is no

guarantee that petitioner will ever have sufficient working

capital and cash reserves to meet its obligations.   There is no

guarantee that petitioner's profit goals will be met.   Indeed,

there is no guarantee that any profit will be made in any

particular year or set of years.   The contingency that a certain

profit level or that sufficient working capital be reached by

petitioner has, as of the end of 1995, not been deemed by

petitioner to have been met in any of its operating years.9    As

of 1995, 13 years after petitioner began accruing royalties owed

to Matrix, petitioner has not paid any of the $6 million or more

in royalties it has accrued to Matrix.

     We find that it was the intent of the parties to the royalty

arrangement that the payment of royalties be conditioned upon a


     9
      We also note that a 30-percent tax is imposed pursuant to
sec. 881(a) on income of foreign corporations not connected with
a U.S. business. Sec. 881(a). Any payment of royalties by
petitioner to Matrix would appear to be subject to the 30-percent
tax. Sec. 881(a); see also sec. 1442(a) (requiring withholding
of the tax). The imposition of the 30-percent tax makes it less
likely that petitioner, under the control of Matrix, would ever
be required to pay the royalties to Matrix.
                             - 16 -

contingency which may never be met.   Because petitioner, under

the control of Matrix, may never be deemed to have met its goals

of a certain profit or cash-flow level or may in any given year

not be profitable at all, petitioner has taken deductions for

expenditures which might never occur.   See United States v.

Hughes Properties, Inc., 476 U.S. at 601-603; Putoma Corp. v.

Commissioner, 601 F.2d at 739-740; Mooney Aircraft, Inc. v.

United States, supra at 406; Burlington-Rock Island R.R. v.

United States, supra at 818-820.    We hold that the all events

test was not satisfied.

     The second issue for determination is whether petitioner may

deduct interest accruals allegedly owed to its foreign parent on

the accrued but unpaid royalties.   Petitioner has accrued

interest on the royalties payable to Matrix, and we have found

that the payment of those royalties is contingent.   It follows

that the accrued interest may not be regarded as an accrued

expense until the years in which the contingency is satisfied and

the obligation to pay the royalties becomes fixed and absolute.

Burlington-Rock Island R.R. v. United States, supra at 819

(citing Pierce Estates, Inc., v. Commissioner, 195 F.2d 475, 477-

478 (3d Cir. 1952), revg. 16 T.C. 1020 (1951)); see also Fox v.

Commissioner, 874 F.2d 560, 563 (8th Cir. 1989), affg. T.C. Memo.

1987-209; Putoma Corp. v. Commissioner, 601 F.2d at 740.

     Finally, respondent determined that petitioner is liable for

accuracy-related penalties under section 6662.   Section 6662(a)
                                - 17 -

imposes a penalty in an amount equal to 20 percent of the

underpayment of tax attributable to one or more of the items set

forth in section 6662(b).     Respondent asserts that the entire

underpayment in issue was due to petitioner's negligence or

disregard of rules or regulations.       Sec. 6662(b)(1).

     Negligence has been defined as the failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances.   Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Respondent's determinations are presumed correct, and petitioner

bears the burden of proving otherwise.       Rule 142(a); Luman v.

Commissioner, 79 T.C. 846, 860-861 (1982).       However, reasonable

reliance upon expert opinion, asserted in good faith, can shield

a taxpayer from penalties for negligence or disregard under

section 6662.    Glick v. Commissioner, T.C. Memo. 1997-65; see

also United States v. Boyle, 469 U.S. 241, 250 (1985); Collins v.

Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988), affg. Dister

v. Commissioner, T.C. Memo. 1987-217.

     The operative facts that control the propriety of

petitioner's accruals present a reasonably close case.

Petitioner had certified public accountants prepare its returns

for each of the years in issue.     They advised that the royalty

and interest accruals be taken as deductions on the tax returns

for the years in issue.     We find that petitioner reasonably

relied upon the opinion of its accountants when claiming the
                              - 18 -

deductions in issue.   We hold petitioner is not liable for the

accuracy-related penalties.



                                         Decision will be entered

                                    under Rule 155.
