                        T.C. Memo. 2001-10



                      UNITED STATES TAX COURT



  I-TECH R&D LIMITED PARTNERSHIP, NATHAN LEWIN, A PARTNER OTHER
           THAN THE TAX MATTERS PARTNER, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20561-97.                 Filed January 22, 2001.


     Nathan Lewin, pro se.

     Judith Cohen, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:   Respondent issued a notice of final

partnership administrative adjustment letter (FPAA) for the years

1984, 1985, 1986, and 1987 to I-Tech R&D Limited Partnership (I-

Tech).   Nathan Lewin (petitioner), a partner other than the tax

matters partner, filed a petition for readjustment of partnership
                               - 2 -

items under Code section 6226.1   After concessions,2 the issues

for decision are:   (1) Whether I-Tech is entitled to deduct

research or experimental expenses of $2,591,225, $2,834,032, and

$1,497,317 under section 174 in its tax years 1984 through 1986,

respectively; and (2) whether I-Tech is precluded from deducting

guaranteed payments of $79,867, $179,501, and $91,221 under

sections 162 and 707(c) in its tax years 1984 through 1986,

respectively.3


     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.
     2
      The amounts claimed by I-Tech on its tax returns differ
from the amounts disallowed by respondent in the notice of final
partnership administrative adjustment (FPAA). The amounts
disallowed in the FPAA are consistent with respondent’s
settlement position in this case as entered into with respect to
some limited partners. Respondent, for purposes of uniformity,
adhered to this position in the FPAA. Consequently, the amounts
disallowed for research or experimental deductions, guaranteed
payments, and management and overhead expenses are less than the
amounts claimed on the partnership tax returns.

     A “no change” agreement accepting the partnership’s return
as originally filed for the year 1987 was made in conjunction
with I-Tech’s consent to adjustments on Forms 870-P(AD),
Settlement Agreement for Partnership Adjustments, for the years
1984, 1985, and 1986.
     3
      I-Tech also deducted management and overhead expenses of
$87,489 in 1984, $279,980 in 1985, and $217,460 in 1986.
Respondent determined that these expenses had to be capitalized.
Respondent determined that I-Tech’s management and overhead
deductions for 1984 would be allowed over a 36-month period, the
1985 deductions would be allowed over a 24-month period, and the
1986 deductions would be increased for amortization additions
from capitalized costs in 1984 and 1985. Since petitioner did
                                                   (continued...)
                                    - 3 -

                              FINDINGS OF FACT4

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

The stipulation of facts, second stipulation of facts, and the

attached exhibits are incorporated herein by this reference.

        I-Tech was organized as a Maryland limited partnership in

1984 with three general partners: (1) Professor Itzhak Yaakov,5

(2) Capital Corp. of Washington (Capital),6 and (3) Lloyd Levin.

Capital7 is owned by Robert Slavitt.

            Mr. Yaakov served in the Israel Defense Forces (IDF) for


        3
      (...continued)
not address this issue in either his original or reply briefs, we
consider it to have been conceded. See Remuzzi v. Commissioner,
T.C. Memo. 1988-8, affd. 867 F.2d 609 (4th Cir. 1989).
     4
        Petitioner has ignored Rule 151(e)(3), which provides, in
part:

     In an answering or reply brief, the party shall set
     forth any objections, together with the reasons
     therefor, to any proposed findings of any other party,
     showing the numbers of the statements to which the
     objections are directed; in addition, the party may set
     forth alternative proposed findings of fact.

     Under the circumstances, we have assumed that petitioner
does not object to respondent’s proposed findings of fact except
to the extent that petitioner’s statements on brief are clearly
inconsistent therewith, in which event, we have resolved the
inconsistencies based on our understanding of the record as a
whole. See Gleave v. Commissioner, T.C. Memo. 1997-276, n.3; see
also Estate of Jung v. Commissioner, 101 T.C. 412, 413 n.2
(1993).
        5
         The advisory general partner.
        6
         The managing general partner.
        7
         Capital is a District of Columbia corporation.
                                 - 4 -

approximately 26 years.   Prior to his retirement from the IDF in

1974, Mr. Yaakov served as chief of research and development.

     Mr. Yaakov met with Mr. Slavitt, an investment banker, in

June 1984.   Mr. Yaakov and Mr. Slavitt decided to form I-Tech as

a limited partnership to fund research projects of four startup

Israeli companies that were previously funded by Advanced

Technology Associates, L.P. (ATA), as well as a fifth Israeli

company.

     Pursuant to a Confidential Private Placement Memorandum

(PPM) dated August 6, 1984, 68 units in the limited partnership

were offered for sale to investors.      The limited partnership

interests were offered in units of $100,000 each.8

     In Mr. Slavitt’s promotional letter to prospective

investors, he stated, in part:

     I-Tech R&D Limited Partnership will provide the funding
     for research and development of five separate R&D
     projects which will be included in our limited
     partnership.

               *    *     *   *      *      *    *

     The Limited Partners’s cash investment will be spread
     over four calendar years and will produce the following
     approximate tax losses per $100,000 unit:


                          Cash Invested               Tax Loss
     1984                    $28,200                  $64,860
     1985                     39,726                   80,103
     1986                     26,180                   53,695
     1987                      5,894                   11,906



     8
      Petitioner purchased a one-half share for $50,000.
                               - 5 -

     When R&D activities are completed and marketing
     commenced, the partnership will receive royalties based
     upon gross sales. In addition, we will have the option
     to convert these royalties to equity in the companies
     at a later date.

     I feel that by diversifying our investment in five
     separate companies, in three exciting areas of high
     technology where Israel has shown definite expertise,
     the potential for success is great.

     Funds for the limited partnership were raised from various

limited partners.   ATA was a limited partner in the I-Tech

partnership.   The limited partnership closed in December 1984.

     I-Tech entered into separate agreements with five Israeli

research and development companies (R&D companies).    The R&D

companies conducted research and development in computer robotics

and related fields (R&D projects).     The R&D companies that I-Tech

entered into agreements with are as follows:

1.   Oshap Technologies, Ltd. and its affiliates; (Oshap);9

2.   Efrat Future Technology, Ltd. (Efrat);10

3.   AiTech Systems, Ltd. (AiTech);11




     9
      Oshap’s research project concerned robots and robotic
production lines--technology that would enable a manufacturer to
simulate a production line on a computer screen.
     10
      Efrat specialized in “digitizing voice” and created an
early digital voice recording and retrieval system.
     11
      AiTech was developing a line of “rugged” computer systems
specifically designed to operate under severe environmental
conditions.
                               - 6 -

4.   Hal Robotics, Ltd. (Hal Robotics);12 and

5.   Cycon, Ltd. (Cycon)13

     The four R&D companies previously funded by ATA are:     Efrat,

AiTech, Hal Robotics, and Cycon.14     The ATA funds were derived

from capital contributions by ATA’s partners and loans from the

Office of Chief Scientist of the Ministry of Industry and Trade

of the State of Israel (Chief Scientist).     Cycon was the only R&D

company for which ATA did not receive a Chief Scientist loan.

     The original contract between ATA and Efrat (ATA R&D

agreement) contained a provision stating that Efrat was

exclusively entitled to manage and control the research and

development project.15   The ATA R&D agreement also provided that

Efrat had the power to do whatever was necessary to exploit the

research and development project.    The original ATA R&D

agreements with Efrat, AiTech, Hal Robotics, and Cycon were

amended to substitute I-Tech for ATA.



     12
      Hal Robotics was developing an “automatic workshop”--a
computer program that would enable an entire product to be
produced by robots.
     13
      Cycon was developing a computer and the necessary software
to control a machine that would mill metal parts automatically.
     14
      As of Sept. 1, 1984, ATA provided the following amounts to
the R&D companies to fund R&D expenses: (1) Eftrat, $1,725,000;
(2) AiTech, $310,000; (3) Hal Robotics, $490,000; and (4) Cycon,
$100,000. Cycon subsequently repaid the $100,000 to ATA.
     15
      Petitioner did not provide copies of the original
agreements between ATA and the other three R&D companies (AiTech,
Hal Robotics, and Cycon).
                                 - 7 -

     On August 3, 1984, Robots & Software International, Inc.

(RSI)16 and I-Tech entered into a contract whereby RSI provided

technical and other consulting services to I-Tech and the R&D

companies.17     RSI agreed, in part, to provide the followings

services:

     (b)     Assist the R&D Companies in carrying out the R&D
             projects; * * *

                 *     *     *     *       *   *     *

     (d)     Advise the R&D companies and * * *[I-Tech]
             generally on matters relating to the execution and
             performance of the R&D agreements and the
             management of the R&D Companies;

                 *     *     *     *       *   *     *

     (g)     Promote contacts between the R&D Companies and
             individuals or institutions, in the United States,
             Israel, and elsewhere * * *;

     (h)     * * *[M]onitor the financial condition and
             management of the R&D companies;

                 *     *     *     *       *   *     *

     (j)     Provide * * * technical assistance to the R&D
             Companies and * * *[I-Tech] as needed in
             connection with the R&D Projects.

     The contract constituted the entire agreement between RSI

and I-Tech.     The contract did not make either RSI or I-Tech the

employee, agent, partner, or legal representative of the other


     16
          RSI is a New York corporation.
     17
      Mr. Yaakov had a controlling interest in Robots & Software
International, Inc. (RSI).
                                      - 8 -

for any purpose whatsoever.        Both RSI and I-Tech acted as

independent contractors.

       On August 3, 1984, WorldTech Israel, Ltd. (WTI),18 State

National Investments, Inc. (WorldTech U.S.),19 and I-Tech entered

into a contract whereby WTI and WorldTech U.S. agreed to provide

management, financial, and consulting services to I-Tech.20

       WTI and WorldTech U.S. agreed, in part, to provide the

followings services:

       (ii) Supervise the activities of the R&D Companies in
            carrying out the R&D Projects, and direct such
            work to the extent that * * *[I-Tech] is entitled
            to do so; * * *

                   *     *     *       *      *   *     *

       (v)     Conduct negotiations on behalf of * * * [I-Tech]
               with the R&D Companies and other entities in
               connection with the R&D Projects.

                   *     *     *       *      *   *     *

    (vii) Assist * * * [I-Tech] and the R&D Companies
          in recruiting qualified personnel in Israel,
          the United States, and other countries.

                   *     *     *       *      *   *     *

       (ix) Locate parties that may be suitable for technical
            cooperation with the R&D Companies.

       (x)     Report to * * * [I-Tech] on the activities of the
               R&D Companies on a regular basis * * *.



       18
            An Israeli corporation.
       19
            A Delaware corporation.
       20
            Mr. Yaakov had a controlling interest in WTI and WorldTech
U.S.
                                - 9 -

     In connection with the R&D projects undertaken by the R&D

companies, RSI agreed to assist WTI in providing services on

behalf of I-Tech.

     The contract constituted the entire agreement among WTI,

WorldTech U.S., and I-Tech.    The contract did not make any of the

parties the employee, agent, partner, or legal representative of

the other for any purpose whatsoever.    Each party acted as an

independent contractor.

Funding

     The Israeli Government, through the Industrial Development

Bank of Israel (IDB), provided loans with respect to each R&D

project.    These loans were limited to an amount equal to 54

percent of the total funds needed for each R&D project (primary

loans).21   I-Tech funded 36 percent of each R&D project using

proceeds from the sale of limited partnership interests and a

$1,585,000 commercial loan from the Israel General Bank, Ltd.

(General Bank).22   Each R&D company contributed the remaining 10


     21
      The limited partners in I-Tech have not repaid any portion
of their pro rata shares of the recourse loans that the
Industrial Development Bank of Israel Limited made on behalf of
the Chief Scientist of the Ministry and Trade in Israel in
connection with the R&D projects.
     22
      I-Tech repaid the recourse loan that the Israel General
Bank, Ltd., made to I-Tech in connection with the R&D projects.
The loan was repaid from the funds received by I-Tech from Efrat,
AiTech, and Oshap when those R&D companies exercised their
options. These transactions were noted on the partnership’s tax
                                                   (continued...)
                                 - 10 -

percent of the total budget from its own source of funds.

     The primary loan through the IDB was made for the sole

purpose of encouraging the conduct of the research and

development in Israel.     Each time I-Tech disbursed funds from the

IDB loan to an R&D company, the R&D company was required, within

72 hours, to lend I-Tech 5.5 percent23 of the amount so disbursed

to that R&D company (secondary loan).24

     In addition to funding the five R&D projects, I-Tech

allocated $990,000 of the offering proceeds to a “blind pool” or

“discretionary account” to be used at the discretion of Capital,

the managing general partner, as additional funding for one or

more of the R&D projects or other R&D projects.     The blind pool

of $990,000 was invested in two other R&D projects promoted by

Mr. Slavitt.25

R&D Agreements

     Under the terms of each R&D agreement, ATA granted I-Tech

certain rights, title, and interest in and to the R&D companies’

existing technology and technology to be developed in the R&D


     22
      (...continued)
returns.
     23
          This was 5.55 percent in the case of Hal Robotics.
     24
      I-Tech repaid the nonrecourse loans from the R&D companies
to I-Tech. These loans were repaid from the funds received by I-
Tech from Efrat, AiTech, and Oshap when those R&D companies
exercised their options. These transactions were noted on the
partnership’s tax returns.
     25
      Medical R&D Associates Limited Partnership and Israel
Technology-5 Limited Partnership.
                              - 11 -

projects.   I-Tech granted a nonexclusive license to the R&D

companies to use the technology for the completion of each R&D

company’s project in return for certain fees and royalty

payments.   I-Tech also granted one or more nonexclusive licenses

to the R&D companies for the commercial exploitation of new

technology, patents (discoveries), and products in return for

royalty payments.

     With respect to Efrat, AiTech, Hal Robotics, and Cycon, the

nonexclusive licensing periods for exploitation of the research

and products began after the research had been successfully

completed and the research had been reduced to practice

(completion date).   For these companies, the nonexclusive

licensing periods were to run until specified levels of royalties

had been received, or until either I-Tech exercised certain

rights to acquire equity in Efrat, AiTech, Hal Robotics, and

Cycon or, in the case of Efrat, AiTech, and Hal Robotics, until

the R&D companies elected to acquire all I-Tech’s rights, title,

and interest to such technology in exchange for royalties and

fees (buy-out option).   Although Cycon did not have a buy-out

option, RSI had an option to acquire the rights to market

products using Cycon discoveries in the United States.

     With respect to Oshap, the nonexclusive licensing period was

to run for 6 months and 1 day after the completion date.     During

this time, I-Tech was to receive royalties from the commercial
                               - 12 -

exploitation.   At the end of the nonexclusive licensing period,

I-Tech granted Oshap the buy-out option.

     The exercise prices of the buy-out options held by Efrat,

Hal Robotics, and AiTech, were based on I-Tech’s investment.

     I-Tech had options to acquire a 20-percent interest in

Efrat, AiTech, Hal Robotics, and certain Oshap affiliates,26 and

a 10-percent interest in Cycon.

Project Restrictions

     The Israeli Government and I-Tech entered into a multiannual

industrial research agreement.27   The agreement contained the

following clause:

     [I-Tech] undertakes to cause the manufacturing of the
     Product to be developed as a result of the Research
     Program to be carried out only in Israel.

     I-Tech’s contracts with each R&D company contained a

prohibition against the manufacture of any product or partial

product taking place outside of Israel without the express

written consent of the Chief Scientist.    This restriction applied

whether the products were manufactured or produced by I-Tech or

by one of the R&D companies.   Additionally, each R&D agreement

included a prohibition against any sublicensing agreements that


     26
      Robcad, Robcad B, or other affiliates holding the rights
to partnership patents and technology.
     27
      Petitioner provided only the multiannual industrial
research agreement regarding Efrat’s research program. The
counterpart agreements for the other four R&D companies were not
provided.
                                - 13 -

allowed the manufacturing of any discoveries outside of Israel

without the express written consent of the Chief Scientist.

There was no assurance that such consent would be considered or

granted.

     The Chief Scientist agreements also restricted I-Tech from

transferring, selling, or using the know-how28 derived from

research and development in Israel without the Israeli

Government’s approval.   There was no assurance that such consent

would be considered or granted.

     In the event that the R&D companies failed to commercialize

the technology within 5 years from the termination of the

project, the rights to the technology passed to the Israeli

Government.

Exploitation of Research

1.   Efrat

     Efrat’s marketing and manufacturing plans were stated in the

PMM, in part, as follows:

     Efrat is negotiating with several PBX manufacturers and
     distributors regarding the marketing of Efrat’s TAVOR
     system. Preliminary discussions have been held with
     several hotel chains and brokerage houses.

               *    *       *   *    *   *    *



     28
      Know-how includes any process, method, patent of invention
and any trademark, blueprint, plan, written material, computer
program, model and prototype which are a result or a part of the
research program.
                                - 14 -

     Efrat contemplates that all manufacturing of the VSF
     [voice storage and forward system] will be done by
     Efrat, with the exception of the printed circuit boards
     and some subsystems (disc drives, cabinets and power
     supplies). The Company has represented that Tadiran
     and certain other companies have expressed interest in
     performing subcontracted manufacturing for Efrat.
     Efrat would hire manufacturing staff to manufacture its
     VSF systems. * * *

     Efrat completed the technology it was developing.29   Within

the required time period, Efrat exercised its option to acquire

all right, title, and interest in the Efrat technology beginning

6 months and 1 day after the research was reduced to practice.

Shortly after exercising its option, Efrat made a public offering

of stock in the United States, and I-Tech exercised its option to

exchange its royalty rights for an equity interest in Efrat.

2.   AiTech

     AiTech’s marketing and manufacturing plans were stated in

the PPM, in part, as follows:

     AiTech has executed an agreement with Intellimac, Inc.
     of Rockville, Maryland. This agreement provides for
     transfer of know-how by Intellimac to AiTech in
     exchange for marketing rights for AiTech products. * *
     * In addition to transfer of know-how, Intellimac and
     AiTech have agreed that Intellimac will have exclusive
     marketing rights in the United States and Canada for
     the product. * * *

               *    *    *      *    *   *   *

     AiTech will do the work related to the packaging of its
     products. AiTech will purchase standard electronic
     components, displays and keyboards manufactured by


     29
      A new generation of voice storage and forward system to be
called “TAVOR”.
                              - 15 -

     others and will subcontract the production of printed
     circuit cards to be incorporated in the products.

     AiTech30 completed the development of the technology it was

developing in the AiTech R&D project.31   Within the required time

period, AiTech exercised its option to acquire all right, title,

and interest in the AiTech technology beginning 6 months and 1

day after the research was reduced to practice.   In December

1988, I-Tech exercised its option to exchange its right to

receive royalties for a 20-percent equity interest in AiTech.

3.   Cycon

     Cycon’s marketing and manufacturing plans were stated in the

PPM, in part, as follows:

     It is contemplated that Cycon will market the proposed
     system in Israel and abroad both directly to end users
     and through distributors. Cycon has not developed any
     marketing forces. Although Cycon presently lacks any
     service capability, it has verbal agreements and
     understandings with machine-tool manufacturers (OEM)
     and distributors in Europe, principally in Italy,
     Spain, Belgium, the United Kingdom, and Germany, as
     well as in the United States, according to which such
     companies will undertake to promote, sell, maintain and
     provide all after-sale services of Cycon products.
     Cycon contemplates that Cycon personnel would service
     the systems in Israel. Cycon expects to enter into
     service agreements with foreign companies in order to
     arrange for servicing of the systems for non-Israel
     users.


     30
      RSI, which was controlled by Mr. Yaakov, owned 29 percent
of AiTech.
     31
      A “ruggedized” computer system specifically designed to
operate under severe environmental conditions.
                             - 16 -

     Cycon contemplates that most manufacturing of the Cycon
     computer will be done by Cycon, except for a limited
     amount of work which will be subcontracted to other
     companies.

     By the end of 1985, Mr. Slavitt and Mr. Yaakov32 determined

that the Cycon technology33 should no longer be funded.   Shortly

after the Cycon R&D project was terminated, Cycon went into

receivership.

     Under the agreement with Cycon, I-Tech was the exclusive

owner of any technology developed by the research.   I-Tech sold

its rights to the Cycon technology to NCT, a company that I-Tech

had located with the assistance of WorldTech.   Because NCT uses

the technology developed in the Cycon R&D project in NCT’s

product-line development, I-Tech is entitled to receive royalty

payments from NCT.

4.   Hal Robotics

     Hal Robotics’ marketing and manufacturing plans were stated

in the PPM, in part, as follows:

     It is expected that sales will be made through the
     appointment of agents and distributors for the products
     in the target markets. Alternative distribution
     channels available to such products are original


     32
      Mr. Yaakov had a 15-percent interest in Cycon plus an
option to acquire an additional 15 percent. Also, RSI, which was
controlled by Mr. Yaakov, owned 30 percent of Cycon and had an
option to acquire an additional 10 percent.
     33
      Development of a micro computer-based numerically
controlled CAD/CAM (i.e., computer-aided design/computer-aided
manufacturing) system to be used in the production of molds and
dies on milling machines.
                                - 17 -

     equipment manufacturers (OEM), which could offer
     products manufactured by Hal Robotics as package deals
     with their own products; also tool manufacturers or
     manufacturers of industrial robots might be
     distributors of Hal Robotics products.

                 *   *      *   *    *   *   *

     Hal Robotics’ work is in the competitive area of
     CAD/CAM technology. The Company believes, however,
     that its focus on the manufacturing rather than the
     design aspect addresses a potentially unfulfilled
     market need and thereby provides a correspondingly
     significant business opportunity. * * *

     Hal Robotics intends to acquire certain of the hardware
     components of its products from third parties. * * *

     Based on their dissatisfaction with the Hal Robotics’ R&D

project,34 I-Tech’s general partners ceased funding the Hal

Robotics’ R&D project in 1986 and terminated the Hal Robotics’

R&D agreement.

5.   Oshap35

     Oshap’s marketing and manufacturing plans were stated in the

PPM, in part, as follows:

     It is anticipated that the marketing of the products
     developed by Oshap companies will be undertaken in
     three ways: (1) through subsidiaries to be established
     in Europe and the United States; (2) through a chain of
     system houses in the United States and Europe; and (3)
     through original equipment manufacturer (“OEM”)
     contracts with other companies. * * *



     34
      Development of a “flexible manufacturing system” under
which a computer would coordinate and direct the execution of
certain manufacturing processes.
     35
      Mr. Yaakov had an indirect interest in an Oshap affiliate,
Roboticad.
                               - 18 -

               *       *   *   *    *    *   *

     It is anticipated that the Oshap Companies will produce
     the software to be integrated in the Robcad
     workstation, if the project is successful. During the
     first stage of the R&D Project, it is not expected that
     Robcad would manufacture any hardware but would
     purchase it from third parties; Robcad would integrate
     such hardware with the software it develops. At a
     later stage, Robcad may manufacture some special
     hardware and firmware, * * *

     After Oshap completed development of the technology it was

developing in the Oshap R&D project,36 two of Oshap’s affiliates,

Robcad and Robcad Computers, exercised their buy-out options to

acquire all rights to the Oshap technology and made lump-sum

payments to I-Tech of $150,000 and $1,100,000, respectively.

After exercising their options, Robcad and Robcad Computers paid

royalties to I-Tech.

     Oshap successfully exploited the Oshap technology.   After

extensive negotiations with Oshap and its affiliates, I-Tech was

able to convert its option to exchange its royalty rights for

equity interests in Robcad and Robcad Computers to an option to

obtain an equity interest in Oshap, the parent corporation which

made a public offering of its stock in the U.S. market.   I-Tech

exercised its option to obtain an equity interest in Oshap and

continues to own an interest in Oshap.



     36
      Development of an advanced computer-aided engineering
workstation for designers and implementers of automated
manufacturing processes that use robots.
                                - 19 -

                                OPINION

I.   Section 174 Deductions

     Section 174 generally allows as a current deduction research

or experimental expenditures which are paid or incurred by the

taxpayer in connection with the operation of a trade or business.

An entity, such as a partnership, may deduct these expenses even

when the expenditures paid or incurred for research or

experimentation are carried on in its behalf by another person or

organization.   See sec. 1.174-2(a)(2), Income Tax Regs.     A

partnership need not be engaged in a trade or business at the

time of the expenditure in order to qualify for a deduction under

section 174(a)(1).     See Snow v. Commissioner, 416 U.S. 500

(1974).   However, during the years in issue there must have been

a “realistic prospect” that the entity in question would enter a

“trade or business” involving the technology being developed.

Diamond v. Commissioner, 92 T.C. 423, 439 (1989), affd. 930 F.2d

372 (4th Cir. 1991).    “If those prospects are not realistic, the

expenditures cannot be ‘in connection with’ a business of the

taxpayer” for the purpose of satisfying section 174.     Spellman v.

Commissioner, 845 F.2d 148, 149 (7th Cir. 1988), affg. T.C. Memo.

1986-403.   Whether activities in connection with a product are

sufficiently substantial and regular to constitute a trade or

business for purposes of section 174 is a factual determination.

See Green v. Commissioner, 83 T.C. 667, 687 (1984).    The
                                - 20 -

management of investments has long been held not to rise to the

level of a trade or business, regardless of the extent of the

investments or the time required to perform the managerial

functions.     See Higgins v. Commissioner, 312 U.S. 212 (1941).

     Petitioner argues that I-Tech controlled the research and

development of the five R&D companies and that the partnership

had a “realistic prospect” of being involved in the exploitation

of any discoveries.    We address petitioner’s arguments in turn.

A.   Control

     Petitioner asserts that by virtue of Mr. Slavitt’s and Mr.

Yaakov’s “active involvement” with the five R&D companies, the

limited partnership controlled the research, and as a result,

establishes that the limited partnership was not a passive

investor.    Petitioner points to testimony by Mr. Slavitt and Mr.

Yaakov regarding an initial inspection tour followed by frequent

visits to Israel and numerous conversations with personnel at

WorldTech,37 RSI, and the five R&D companies.    While Mr. Slavitt

and Mr. Yaakov may have initially inspected the companies doing

the research to determine their potential for success and

communicated with people at WorldTech, RSI, and the five R&D

companies on a frequent basis, we believe such activity was

undertaken on behalf of I-Tech in its role as an investor in the


     37
      It is not clear whether Mr. Yaakov was referring to
WorldTech Israel, Ltd., or its wholly owned subsidiary WorldTech
U.S. Our analysis does not change in either case.
                                 - 21 -

R&D companies, Mr. Slavitt’s role as a promoter of I-Tech, and

Mr. Yaakov’s ownership interest in WTI, RSI,38 and three R&D

companies.39    The majority of Mr. Slavitt’s and Mr. Yaakov’s

efforts was spent trying to assure I-Tech its stream of “royalty”

income.   Such an interest in obtaining royalties is inherently an

“investor-like interest”, Green v. Commissioner, 83 T.C. at 688-

689, and Mr. Slavitt’s and Mr. Yaakov’s efforts    amounted to no

more than the management and protection of an investment.    The

management of investments is not a trade or business irrespective

of the amount of time required to perform the managerial

functions.     See id. at 688.

     Petitioner asserts that Mr. Slavitt and Mr. Yaakov were in

charge, on a “hands on” basis, of the development of the

technology.40    The fact that a taxpayer may have taken an active

     38
      Mr. Yaakov had a controlling interest in RSI, WTI, and
WorldTech U.S.
     39
      Mr. Yaakov had a 15-percent equity interest in Cycon plus
an option to acquire an additional 15 percent. RSI, which was
controlled by Mr. Yaakov, owned 30 percent of Cycon, had an
option to acquire an additional 10 percent, and owned 29 percent
of AiTech. Mr. Yaakov also had an indirect interest in Oshap
affiliate, Robitcad.
     40
      On brief, petitioner relies on Scoggins v. Commissioner,
46 F.3d 950 (9th Cir. 1995), revg. T.C. Memo. 1991-263. Scoggins
is distinguishable from the instant case. The partnership in
Scoggins had only two partners. The two partners invented a new
type of “pancake-heated” epitaxial reactor and contributed all
the technology associated with the design and production of that
product to the partnership. The partners then contracted with a
corporation that they had formed and controlled to do the
research necessary to develop the technology into a marketable
                                                   (continued...)
                             - 22 -

role in directing the research does not, by itself, place a

taxpayer in a trade or business.   See id. at 690.   An entity that

has no contractual control over the activities in which it

invests is merely an investor and cannot be engaged in a trade or

business in connection with those activities.   See Diamond v.

Commissioner, 930 F.2d at 376.

     In the instant case, the R&D agreements did not provide I-

Tech with the right to control the research and development

activities of any of the R&D companies.   Indeed, the original R&D

agreements41 between ATA and Efrat, which the subsequent R&D


     40
      (...continued)
product. See id. at 953. The research “was done under the
guidance of * * * [the partners] with the assistance of three
corporate employees.” Id. Based on the particular facts in that
case, the court concluded “that the partnership had a realistic
prospect of subsequently entering into its own business in
connection with the fruits of the research if the research was
successful.” Id. at 956.

     In the instant case, I-Tech entered into agreements with
five preexisting R&D companies organized and controlled by other
parties. No one at I-Tech invented or developed any of the
discovered technology, and the employees of the Israeli R&D
companies, not Mr. Slavitt or Mr. Yaakov, were primarily
responsible for performing the research.
     41
      As noted in the findings of fact, petitioner provided only
one original contract between ATA and an R&D company. The R&D
agreements executed subsequently between I-Tech and the R&D
companies are all similar and are based on the original
agreements between ATA and the four original R&D companies
(Efrat, AiTech, Hal Robotics, and Cycon). Mr. Slavitt testified,
and the agreements with I-Tech confirm, that the R&D agreements
were based on the original agreements with ATA. Therefore, we
conclude that the right to control the research and development
                                                   (continued...)
                             - 23 -

agreements between I-Tech and the R&D companies were based on,

confirm that the R&D companies had complete control over the

research and development of their respective projects.   I-Tech

did not control the research and development of the five R&D

companies.

B.   Exploitation of New Products

     Petitioner asserts that I-Tech anticipated exploiting any

discoveries on its own and that no one else could do so.

Petitioner points to a statement within the PPM indicating that

the purpose of funding the R&D companies is to acquire certain

technologies and to exploit those projects commercially.

However, the PPM does not contain any specific plans or forecasts

relating to the possibility that I-Tech might itself engage in

the marketing of any discoveries, nor does the PPM mention I-

Tech’s plan for hiring staff experienced in the areas of

marketing new technology or acquiring real or personal property.

See, e.g., Harris v. Commissioner, T.C. Memo. 1990-80, affd. 16

F.3d 75 (5th Cir. 1994).

     The PPM sets forth the marketing and manufacturing plans for

each R&D company and describes in detail which R&D company or

third party will carry out each function.   The PPM fails to



     41
      (...continued)
provided in the original agreement between Efrat and ATA is also
found in the agreements with the other R&D companies.
                              - 24 -

mention I-Tech’s expected or anticipated involvement in the

marketing or production of any discoveries.

     In Mr. Slavitt’s promotional letter to potential investors,

he stated that the limited partnership will provide the funding

for research and development of five separate R&D projects.    He

further stated that when the research and development activities

were completed and marketing commenced, I-Tech would receive

royalties based upon gross sales and that options existed

allowing the royalties to be converted into equity in the R&D

companies at a later date.   Mr. Slavitt’s letter does not mention

or even suggest that I-Tech intended to exploit any successfully

developed technology on its own.

     Mr. Slavitt’s promotional letter, read in conjunction with

the PPM, leads us to the conclusion that the plan from the

beginning was for the R&D companies to exercise their buy-out

options and for I-Tech to exercise its equity options in the R&D

companies or their affiliates.   Indeed, the buy-out options

essentially guaranteed that I-Tech did not have a realistic

prospect of exploiting any discoveries in its own trade or

business.   Since the R&D companies could exercise the buy-out

options after a minimal waiting period, they would surely

exercise the options if their projects were profitable enough to

justify incurring the cost of manufacturing and marketing.     As a

result, I-Tech stood to receive production and marketing rights
                                 - 25 -

only in an economically unsound venture.      In the event that the

R&D companies failed to commercialize the technology within 5

years from the termination of the project, the rights to the

technology passed to the Israeli Government.

     In the instant case, the actions of each successful R&D

company provide further support for our conclusion that I-Tech

had no realistic prospect of entering a “trade or business”

involving new discoveries.42     Efrat, AiTech, and Oshap all

completed development of their respective technologies, and in

each instance, the R&D company exercised its buy-out option and

I-Tech exercised its equity options.      The R&D companies that

successfully developed their technologies were the ones to

exploit their discoveries.

     Petitioner argues that I-Tech was not legally restricted

from marketing the research.     Petitioner points out that four of

the five R&D companies43 had a 6-month nonexclusive option period

in which to exploit the technology after it was completed.      Thus,



     42
      Although our decisions should not be based on hindsight,
see Diamond v. Commissioner, 92 T.C. 423, 443 (1989), affd. 930
F.2d 372 (4th Cir. 1991), we may take into account a taxpayer’s
actions in years subsequent to the years in issue in evaluating
the taxpayer’s prospects during the years in issue, see Levin v.
Commissioner, 832 F.2d 403, 406 n.3 (7th Cir. 1987), affg. 87
T.C. 698 (1986) (Tax Court was entitled to inquire whether
subsequent events were consistent with its judgment of the facts
available in the year in issue).
     43
          Efrat, AiTech, Hal Robotics, and Cycon.
                                 - 26 -

according to petitioner, I-Tech could have legally marketed

products during or after the 6-month period.

     The question is not whether it is possible in principle, or

by further contract, to engage in a trade or business, but

whether in reality, the taxpayer possessed the capability in the

years before the Court to enter a new trade or business in

connection with the discovery.     See Diamond v. Commissioner, 930

F.2d at 375.   The answer to the question of reality must be found

in economic reality.   See id.    Economically, it was not in I-

Tech’s interest to market the discoveries/products on its own

behalf during the 6-month nonexclusive period.    I-Tech was

entitled to royalty income from each R&D company that

successfully completed its research and reduced it to practice

during the nonexclusive option period.    If the R&D companies were

successful in exploiting their technology, they would exercise

their buy-out options to acquire all rights, title, and interest

in the technology at the expiration of the nonexclusive license

period and continue to pay I-Tech royalty income.    I-Tech then

had the right to convert its royalty interests into substantial

equity interests in successful R&D companies.

     Finally, the restrictions imposed by the Israeli Government

seriously undermined I-Tech’s ability to exploit the products in

the future.    Under the terms of the Chief Scientist Agreement,

only I-Tech in its independent capacity could obtain any patent
                               - 27 -

with respect to the project.    However, the patent could not be

exploited because know-how and the right to manufacture the

product could not be transferred out of Israel without the

Israeli Government’s approval.    Furthermore, in the event that I-

Tech did not exploit the technology, the rights to such

technology would pass to the Israeli Government at the end of 5

years.   The PPM warned prospective investors that “there is no

assurance” that the Israeli Government would grant approval to

transfer know-how outside of Israel.

      We are unconvinced that there was, during the years in

issue, any realistic prospect that I-Tech would exploit any

discoveries in a trade or business.     We find that I-Tech served

as a financing vehicle set up to fund five Israeli R&D companies

in exchange for a stream of royalty payments convertible into

equity interests in the R&D companies or their affiliates.

      We hold that I-Tech is not entitled to deduct research or

experimental expenses of $2,591,225, $2,834,032, and $1,497,317

under section 174 in its tax years 1984 through 1986,

respectively.

II.   Guaranteed Payments

      Respondent determined that deductions taken as guaranteed

payments of $79,867 in 1984, $179,501 in 1985, and $91,221 in

1986 were nondeductible.    Petitioner did not make any argument

regarding these deductions in his original brief.    In
                                - 28 -

petitioner’s reply brief, he argues that the challenged payments

were ordinary and necessary business expenses and thus

deductible.

     For a guaranteed payment to be a partnership deduction, it

must meet the same tests under section 162 as it would if the

payment had been made to a person who is not a member of the

partnership.    See sec. 707(c); sec. 1.707-1(c), Income Tax Regs.

Section 162(a) generally allows a deduction for “all the ordinary

and necessary expenses paid or incurred during the taxable year

in carrying on any trade or business”.    Petitioner bears the

burden of establishing which fees, or portions thereof, are

deductible.    See Rule 142(a); Welch v. Helvering, 290 U.S. 111

(1933).

     Petitioner neither established I-Tech’s entitlement to the

deductions nor substantiated the amounts claimed as guaranteed

payments.     We sustain respondent’s determination for the years in

issue and hold that I-Tech is not entitled to deduct guaranteed

payments of $79,867 in 1984, $179,501 in 1985, and $91,221 in

1986.

     To reflect the foregoing and the parties’ concessions,



                                      Decision will be entered

                                 pursuant to Rule 155.
