                        T.C. Memo. 1997-504



                      UNITED STATES TAX COURT



           CACTUS WREN JOJOBA, LTD., CECIL R. ALMAND,
               TAX MATTERS PARTNER,1 Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


            YUMA MESA JOJOBA, LTD., WILLIAM WOODBURN,
                TAX MATTERS PARTNER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 14505-87, 25138-87.     Filed November 10, 1997.



     Frederick R. Schumacher, for petitioners.

     Rodney J. Bartlett and Brian M. Harrington, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     DAWSON, Judge:   These cases were assigned to Special Trial

Judge Norman H. Wolfe pursuant to the provisions of section


1
     These cases are consolidated herewith for purposes of trial,
briefing, and opinion.
                               - 2 -

7443A(b)(4) and Rules 180, 181, and 183.2   The Court agrees with

and adopts the opinion of the Special Trial Judge, which is set

forth below.

               OPINION OF THE SPECIAL TRIAL JUDGE

     WOLFE, Special Trial Judge:   Cactus Wren Jojoba, Ltd.

(Cactus Wren) is a Texas limited partnership to which the

provisions of sections 6221-6233 (the TEFRA partnership

provisions)3 are applicable.   By notice of final partnership

administrative adjustment (FPAA) respondent determined the

following adjustments to the partnership return of income of

Cactus Wren for the taxable year 1983:   (1) Disallowance of

$164,057 claimed as qualified research and development

expenditures under section 174; and (2) disallowance of $10,500

claimed as a deduction for tax counseling fees.   Respondent also

determined that, in the alternative, if the research and

experimentation expenditure were allowed as a deduction, it would

be an item of tax preference under section 57(a)(6).   Cecil R.

Almand (Almand), as tax matters partner (TMP), timely filed a

petition with this Court.


2
     All section references are to the Internal Revenue Code in
effect for the tax years in issue, except as otherwise indicated.
All Rule references are to the Tax Court Rules of Practice and
Procedure.
3
     The so-called TEFRA partnership provisions, secs. 6221-6233,
were added to the Code by the Tax Equity and Fiscal
Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, sec. 402(a),
96 Stat. 648.
                                 - 3 -

     Yuma Mesa Jojoba, Ltd. (Yuma Mesa), is a Texas limited

partnership to which the TEFRA partnership provisions are

applicable.   By notice of FPAA respondent determined the

following adjustments to the partnership return of income of Yuma

Mesa for the taxable year 1982:    (1) Disallowance of $1,298,031

claimed as qualified research and experimental expenditures under

section 174; (2) disallowance of $9,000 claimed as a deduction

for tax counseling fees; and (3) disallowance of $750 claimed as

a deduction for guaranteed payments to partners.   Respondent also

determined in the alternative that, if the research and

experimentation expenditure were allowed as a deduction, it would

be an item of tax preference under section 57(a)(6).   William

Woodburn (Woodburn), as TMP, timely filed a petition with this

Court.

     The issue remaining for decision is whether the Yuma Mesa

and Cactus Wren partnerships are entitled to losses for the

taxable years 1982 and 1983, respectively, resulting from claimed

deductions attributed to research and development expenses.   In

their opening brief, petitioners make an alternative argument

that the partnerships are entitled to an abandonment loss under

section 165 for 1987.   The 1987 tax year is not before the Court

with respect to these consolidated cases, and therefore we

decline to address this issue.
                                - 4 -

                         FINDINGS OF FACT

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

The stipulation of facts and the exhibits attached thereto are

incorporated herein by this reference.

     The jojoba plant is a shrub that is native to the Sonora

Desert region in Arizona, California, and Mexico.    A jojoba plant

may live more than 100 years.    The female jojoba plant produces a

seed, sometimes referred to as a bean, that contains

approximately 50 percent by weight of an unusual oil.    Jojoba oil

is actually a liquid wax ester, unlike the triglyceride oils

typically produced by plants, and is similar to sperm whale oil.

     It takes 5 years or more for a jojoba plant to produce seeds

in a harvestable quantity.    Approximately 20 pounds of jojoba

seeds are needed to produce 1 gallon of jojoba oil.    Jojoba oil

is useful for a variety of purposes, ranging from cosmetics and

shampoos to industrial lubricants.

     The ban in 1971 on the importation of sperm whale oil and

products using that oil stimulated an interest in the commercial

production of jojoba oil.    During the 1970's and the early

1980's, jojoba oil was available only from native jojoba plants.

At that time in the United States, there were only a few

commercial-size jojoba plantations, all of which were in

developmental stages.   Domestication studies were being conducted

in the United States during that time at the University of

California at Riverside and the University of Arizona, among
                               - 5 -

other places.

     Yuma Mesa entered into an agreement with Hilltop

Plantations, Inc., to provide agricultural research and

development services with respect to the growing of jojoba on

land in Yuma, Arizona (plantation I).   Cactus Wren entered into

an agreement with Mockingbird Plantations, Inc., to provide

agricultural research and development services with respect to

the growing of jojoba on land in Yuma, Arizona (plantation II),

adjacent to plantation I.   The ownership of Hilltop Plantations,

Inc., and Mockingbird Plantations, Inc., is identical.    Neither

Yuma Mesa nor Cactus Wren engaged in any activity other than to

enter into agreements described herein and transmit payments to

Hilltop Plantations, Inc., and Mockingbird Plantations, Inc.

     1.   Yuma Mesa Jojoba, Ltd.4

     When the petition was filed, the principal place of business

of Yuma Mesa was Dallas, Texas.

     On December 31, 1982, Yuma Mesa was organized by Woodburn

and G. Dennis Sullivan (Sullivan) as a limited partnership with a

described purpose of conducting research and development

involving the jojoba plant.   Woodburn and Sullivan were co-




4
     Although Cactus Wren is the named partnership in these
consolidated cases (since the petition filed by its tax matters
partner bears the lowest docket number), we first discuss the
formation of the Yuma Mesa limited partnership, which is the
primary partnership in these transactions.
                               - 6 -

general partners of Yuma Mesa, and Woodburn was TMP.5   No

investments in Yuma Mesa were made prior to December 31, 1982,

and no activity, other than document execution, concerning Yuma

Mesa occurred during 1982.   The parties have stipulated that Yuma

Mesa began business on December 31, 1982.    Using the accrual

method of accounting and an election under section 174, Yuma Mesa

deducted $1,298,031 as research and development expenses for the

taxable year ending on December 31, 1982.    However, no activity

under the research and development agreement occurred prior to

December 31, 1982.

     In 1982, Woodburn and Sullivan were partners in the law firm

of Woodburn and Sullivan located in Dallas, Texas.    Sometime in

1982, one of the principals of the accounting firm Meinke, Damer,

and Peterson6 (Meinke firm) approached Sullivan or Woodburn

regarding the possibility of having both of them serve as the

general partners of a limited partnership with a described

purpose of conducting research and development of the jojoba

plant and its product, the jojoba nut (or bean).    Sullivan and

Ray Meinke (Meinke), had known each other since Sullivan's

graduation from law school in 1963.    Over the years, they


5
     William Woodburn retired in 1985 for health reasons and
resided in Hawaii at the time of trial. His co-general partner,
G. Dennis Sullivan (Sullivan), testified at trial. Sullivan is a
party to these cases pursuant to sec. 6226(c) and (d).
6
     The principals were Raymond Meinke (Meinke), Keith Damer
(Damer), and Marlin Peterson (Peterson).
                               - 7 -

established a social and professional relationship.   As a result

of Sullivan's personal relationship with Meinke, Sullivan and

Woodburn were designated as co-general partners of Yuma Mesa.

     The existence of the jojoba industry came to the attention

of the principals of the Meinke firm through the efforts of a

business client, Almand, who attended a seminar on jojoba and

reported that at the seminar he had been told that jojoba was

"the thing of the future."   Almand's enthusiasm about jojoba led

the principal members of the Meinke firm to conduct their own

inquiry into the jojoba industry.   This inquiry included many

phone calls and requests for prospectuses and copies of

agreements used in setting up a jojoba venture.   Satisfied with

the information they received, the principals of the Meinke firm

decided to become involved in the jojoba industry.

     Sullivan and Woodburn also investigated the jojoba industry.

Neither Woodburn nor Sullivan, both attorneys, had any prior

experience in agriculture or in the growing of jojoba.    Woodburn

and Sullivan attended two seminars aimed at potential investors

in the jojoba industry, and Woodburn gathered together some

available literature on jojoba.   At least one, if not both, of

the seminars Woodburn and Sullivan attended was organized by the

Meinke firm.

     Yuma Mesa was financed through a private placement as

described infra.   The operation was conducted by Hilltop

Plantations, Inc., and Mesa Plantation, Inc., with management and
                                  - 8 -

supervision by Agricultural Investments, Inc., pursuant to

contract, as described infra.

        Sullivan never traveled to Yuma, Arizona, to inspect the

site of the plantation.     Woodburn visited the site in Yuma two or

three times before the abandonment of the partnership.        As

general partners, Sullivan and Woodburn sent photographs and

letters regarding the growth of the jojoba plants to Yuma Mesa's

limited partners at least twice a year.

        Toward the end of 1986 it became apparent that the weather

in Yuma, Arizona, would not permit successful operation of a

jojoba plantation.     The cold winter temperatures damaged the

flowers on the jojoba plants, preventing the development of the

jojoba bean.      The shareholders of Hilltop Plantations, Inc., the

research contractor, believed that wind machines were necessary

to overcome the effect of the cold weather.      The general partners

of Yuma Mesa were unable to raise the additional capital needed

from investors to purchase the wind machines.        Yuma Mesa then

abandoned development of plantation I in 1987.

             a.   The Private Placement Memorandum

     The Meinke firm, with the assistance of counsel, prepared

the private placement memorandum (the offering) for Yuma Mesa.

Sullivan and Woodburn reviewed draft copies of the offering

before any subscriptions were taken for Yuma Mesa.       Neither

Woodburn nor Sullivan participated in raising money for Yuma

Mesa.     The funds were raised for Yuma Mesa through the networking
                                - 9 -

efforts of the Meinke firm.    The offering, dated July 30, 1982,

provided for a maximum capitalization of $1,714,300 consisting of

140 limited partnership units, at $12,245 per unit.    Each unit

consisted of a cash downpayment of $3,571 and an interest-bearing

promissory note in the principal amount of $8,674, payable over a

period of 48 months with interest of 10 percent per year, at the

rate of $220 per month.    The offering was limited to "qualified

investors," described as investors with a minimum net worth

(exclusive of home, furnishings, and automobiles) of $150,000

and/or investors who estimate that some portion of their current

calendar year taxable income will be subject to a combined

Federal and State income tax rate of 35 percent or more, or had

gross income in the previous taxable year of not less than

$75,000.   The Yuma Mesa partnership subscribed 112 units for a

total capitalization of $1,371,440, which facilitated farming

operations on 130 acres of real property located in the environs

of Yuma, Arizona, for a period of approximately 4 years.

     According to the offering circular, Yuma Mesa was to be

"formed to engage in research and development and, thereafter,

participate in the marketing of the products of the jojoba plant,

including, but not limited to, the beans, liquid wax and other

by-products."    The offering circular identified Hilltop

Plantations, Inc., as the contractor selected to carry out the

research and development (R&D) program under an R&D Agreement.

           b.   Hilltop Plantations, Inc.
                              - 10 -

     Hilltop Plantations, Inc. (HTP), was a Texas corporation

owned in equal shares by Marlin Peterson, Raymond Meinke, Keith

Damer (principals of the Meinke firm) and one of the accounting

firm's clients, Almand.   HTP was capitalized with $1000, the

minimum amount required under Texas law.   Each shareholder

contributed $250.   HTP executed an exclusive research and

development contract with Yuma Mesa on December 31, 1982, for the

stated purpose of "conducting research to develop a commercially

marketable product from the seed or beans produced from the

plantation on which the research is conducted."   No other bids

were considered for the role of prime research contractor.    As

the prime research contractor, HTP then further subcontracted the

research and development work to Mesa Plantations, Inc.    Mesa

Plantations, Inc., in turn, signed an agreement with Agricultural

Investments, Inc. (AI), for AI to manage and supervise work on

the plantation.

          c.   Mesa Plantations, Inc.

     Mesa Plantations, Inc. (Mesa), an Arizona corporation, was a

wholly owned subsidiary of HTP.   Therefore, the shareholders of

HTP--Peterson, Meinke, Damer, and Almand--controlled the

activities of Mesa.

     On August 5, 1982, Mesa entered into an Agricultural Lease

Agreement with Hilltop Ventures, a Texas general partnership, for

130 acres in Yuma, Arizona, with a purpose, according to the

recitation in the lease, to conduct "a Research and Development
                                 - 11 -

program for the purpose of undertaking research and thereafter

developing a jojoba plantation."      The partners in Hilltop

Ventures--Peterson, Meinke, Damer, and Almand--were also the sole

shareholders of HTP.     Under the terms of this lease, Mesa was to

pay a rental fee of $450 per acre, per year, for a period of 20

years, starting on October 1, 1982.       Mesa, as lessee, in addition

to conducting a broadly described "R&D Program", was required to

furnish all material, labor and equipment, seed, fertilizer, and

supplies for the farm, maintain all wells and irrigation and

improvements to the property in working order, pay all utility

charges and insurance costs, and pay for all subcontractors.      The

lessor was required to pay tax and assessments on the premises.

     Concurrently with the execution of the research and

development agreement between Yuma Mesa and HTP, on December 31,

1982, Yuma Mesa executed an exclusive license agreement with

Mesa.     This exclusive license agreement granted Mesa "the

exclusive right to utilize the technology developed for the

account of the Licensor * * * [Yuma Mesa]," in exchange for

"royalties * * * payable to Licensor * * * [Yuma Mesa] based upon

cumulative annual gross revenue from sales," of the seeds or

beans of the jojoba plant.

             d.   Agricultural Investments, Inc.

        On December 31, 1982, Mesa entered into a management

contract with AI, a California corporation, to develop the 130

acres leased from Hilltop Ventures as a jojoba plantation
                              - 12 -

(plantation I).   Don and Kelly Shooter owned AI.   Earlier in the

year, the Shooters told the principals of the Meinke firm that

the climate in Yuma, Arizona, was suitable for growing jojoba.7

Don Shooter was the onsite manager and handled all of the

activities related to plantation I.    No one from AI testified at

the trial.

     AI provided the physical labor involved in the preparation

of plantation I for farming jojoba and the maintenance of the

jojoba plantation.   Pursuant to its management contract with

Mesa, AI tilled the ground, planted the jojoba, installed the

irrigation system, and applied herbicide and fertilizer to the

jojoba.   Funding for these activities was provided pursuant to

the contracts described above among Yuma Mesa, HTP, Mesa, and AI.

          e.   Hilltop Ventures, later Townhill Equities, Inc.

     Hilltop Ventures8 was originally formed as a general


7
     Joint exhibit 3-C, Description of the Project, as set forth
in the private placement memorandum states:

     Climatic conditions in the area * * * [Yuma, AZ] are
     believed to be quite favorable for growing Jojoba.
     High and low daily temperatures recorded since 1949
     have ranged from a summer high of 119/F to a winter
     night-time low of 22/F. Average annual rainfall is
     approximately three inches.
8
     These cases concern the planting of jojoba on 160 acres
owned by Hilltop Ventures. Throughout the trial, witnesses refer
alternately to Hilltop Ventures and Hilltop Equities. Hilltop
Equities, a general partnership, owned another 160 acres of land
in Yuma, Ariz., that might have been developed as a jojoba
plantation if Yuma Mesa and Cactus Wren had been successful.
Hilltop Equities was capitalized by its general partners,
                                                   (continued...)
                               - 13 -

partnership that purchased 160 acres for farming of jojoba in

Yuma, Arizona, in March or April of 1982.   Peterson, Meinke,

Damer, and Almand, the original members of the partnership

provided the capital for the purchase of the 160 acres.   There is

no evidence in the record regarding the amount of capital

provided by Peterson, Meinke, or Damer.   Almand, a 25-percent

owner in both HTP and Mesa, advanced $100,000 to Hilltop Ventures

to purchase this land.   Funds paid for subscriptions to Yuma Mesa

and Cactus Wren were used subsequently to repay the $100,000

Almand advanced Hilltop Ventures as a downpayment for the land.

Additionally, Almand provided working capital as needed to keep

the Hilltop Ventures operating.   Hilltop Ventures purchased the

irrigation equipment necessary to prepare the land in Yuma,

Arizona, for the planting of jojoba.    Otherwise, the land did not

need extensive development work and was suitable for immediate

farming.

     Subsequent to the purchase of the 160 acres in Yuma,

Arizona, in order to limit the shareholders' liability, Hilltop

Ventures was incorporated in Texas as Townhill Equities, Inc.,

also owned in equal shares by Peterson, Meinke, Damer, and

Almand.    Following a tax-free exchange, Townhill Equities, Inc.,



8
 (...continued)
Peterson, Meinke, Damer, and Cecil Almand, with $80,000 cash, and
the balance in notes. Testimony at trial indicates that the
$80,000 investment was repaid through proceeds of "land lease"
payments under the rental agreement.
                               - 14 -

succeeded Hilltop Ventures as owner of the 160 acres in Yuma,

Arizona.

     As previously noted, on August 5, 1982, Hilltop Ventures, as

lessor, entered into an agricultural lease agreement, effective

October 1, 1982, with Mesa, the lessee.   Pursuant to the terms of

the agreement, Hilltop Ventures leased 130 acres9 of the total

160 acres to Mesa for the purposes of carrying out the research

and development program as described therein.   Because the Yuma

Mesa offering had not been completely sold, a reduction occurred

in the leased acreage from the original 160 to 130 acres.   The

term of the lease was for 20 years with the basic rental of $450

per acre, per year, payable in advance.

     2.    Cactus Wren Jojoba, Ltd.

     When the petition was filed, the principal place of business

of Cactus Wren was Dallas, Texas.

     On December 31, 1983, Almand organized Cactus Wren, as a



9
     The legal description of the property was attached as
exhibit A to the lease agreement. The property was described as
follows:

     All that real property situated in the County of
     Yuma, State of Arizona described as follows: The
     Northeast Quarter (1/4) of Section Fourteen (14),
     Township Ten (10) South, Range Twenty-three (23)
     West, Gila and Salt River Base and Meridian, Yuma
     County, Arizona, being 160 acres more or less.

A handwritten drawing reflecting the configuration of the real
estate subject to the lease accompanied the legal description.
The handwritten drawing clearly demonstrated that only 130 acres
were subject to the lease.
                              - 15 -

limited partnership with a described purpose of conducting

research and development involving the jojoba plant.   Since Yuma

Mesa had raised only enough funds to plant jojoba on 130 acres of

the 160 acres owned by Hilltop Ventures, Cactus Wren was designed

to raise additional capital from investors to cover the cost of

planting jojoba on the remaining 30 acres owned by Hilltop

Ventures.   As a result of his involvement with Yuma Mesa, Almand

volunteered to become the general partner of Cactus Wren.    Almand

was engaged in business as a general contractor and had no

previous experience farming jojoba.    Almand claims to have first

obtained information regarding investments in jojoba from the

principals of the Meinke firm.10

     When Almand became general partner of Cactus Wren, he

already had invested in another limited partnership, Yuma Mesa,

discussed above.   Almand's investment in Yuma Mesa was

approximately $100,000.   As an investor in Yuma Mesa, Almand

visited the site of plantation I numerous times and spoke with

Don and Kelly Shooter, the farm managers employed by AI.

     As general partner, Almand visited the site of plantation II

approximately six to eight times over a period of 4 to 5 years

and sent out four letters to the limited partners reporting on



10
     Peterson, a member of the Meinke firm, testified that Almand
brought the information about investing in jojoba to the firm
after he attended a seminar on the subject. The precise
chronology of the investigation by Almand and the three members
of the accounting firm is immaterial.
                                 - 16 -

the growth of the jojoba plants.      Each letter included

photographs of the jojoba plants.

     By 1986, Almand had learned that the cold night weather in

Yuma prevented the growth of the jojoba beans and that wind

machines were needed to prevent the frost damage.      Almand could

not raise the additional capital from the investors in Cactus

Wren to purchase the wind machines.       Almand conceded that he was

not able to raise the additional capital due to the recent

passage of the 1986 Tax Reform Act which eliminated taxpayers'

interest in "investments" structured like the partnerships here

in issue.     Cactus Wren abandoned development of plantation II in

1987.

             a.   The Private Placement Memorandum

        The private placement memorandum (the offering) for Cactus

Wren, dated April 3, 1983, provided for a maximum capitalization

of $343,000 consisting of 140 limited partnership units, at

$2,450 per unit.      The purchase price was payable in cash upon

execution of the subscription agreement.      The Cactus Wren

partnership ultimately was capitalized at $196,000, all cash,

consisting of 80 units at $2,450 per unit.      Cactus Wren was

funded totally with cash because the purchase of rooted cuttings

required a large initial capital outlay.      According to the

offering, Cactus Wren was to "engage in research and development

and, thereafter, participate in the marketing of the products of

the jojoba plant including, but not limited to, the beans, liquid
                                - 17 -

wax and other by-products."   The offering identified Mockingbird

Plantations, Inc., as the contractor selected to carry out the

R&D program.

          b.   Mockingbird Plantations, Inc.

     Mockingbird Plantations, Inc. (MBP), was a Texas corporation

established to be the prime research contractor for Cactus Wren.

Peterson, Meinke, Almand, and Damer, the sole shareholders, owned

equal shares in MBP.   The ownership of MBP mirrored that of HTP,

the prime research contractor for Yuma Mesa.       On December 31,

1983, MBP executed an exclusive research and development contract

with Cactus Wren, in which Cactus Wren engaged MBP "for the

purpose of conducting research to develop a commercially

marketable product from the seed or beans produced from the

plantation on which the research is conducted."       Cactus Wren paid

MBP $164,645 on December 31, 1983.       Cactus Wren solicited no

other bids for this position.

     Concurrently with the research and development contract,

Cactus Wren entered into a license agreement with MBP that gave

MBP "the exclusive right to utilize the technology developed for

the account of the Licensor * * * [Cactus Wren]" in consideration

for the payment by MBP of royalties based on the gross revenue

from commercial farming and marketing of the jojoba plantation.

     MBP, as a newly formed research and development contractor,

had no experience in the jojoba field.

          c.   Agricultural Investments, Inc. (AI)
                               - 18 -

     On December 31, 1983, MBP entered into a verbal agency

agreement with Mesa, described in a written memorandum of agency

agreement dated August 5, 1985.    Pursuant to the terms of this

agreement, Mesa engaged AI in a research and development

management agreement similar to the agreement Mesa negotiated

between AI and Mesa's parent corporation, HTP.    AI handled all of

the physical work that occurred on the 17.2-acre plantation

related to Cactus Wren.

           d.   Townhill Equities, Inc.

     On December 31, 1983, MBP leased 17.2 acres11 (plantation

II) from Townhill Equities, Inc., "for the purpose of undertaking

research and thereafter developing a jojoba plantation of

approximately 17.2 acres".    Under the terms of this lease, Mesa

agreed to pay a rental fee of $450 per acre, per year, for a

period of 20 years, starting on December 1, 1983.    Plantation II

was located adjacent to plantation I.     Townhill Equities, Inc.,

and MBP were both owned in equal shares by Peterson, Meinke,

Damer, and Almand.

     3.   The Expert--Patrick Luna

     Patrick Luna (Luna) testified for respondent as to whether


11
     The legal description of the property was attached as
exhibit A to the lease agreement. The property was described as
follows:

     The Northeast quarter (NE1/4) of Section Fourteen
     (14), Township Ten (10) South, Range Twenty-three (23)
     West, Gila and Salt River Base and Meridan, Yuma
     County, Arizona.
                              - 19 -

any research or experimentation activities were conducted

pursuant to the exclusive research and development agreements

entered into between Yuma Mesa and HTP, and between Cactus Wren

and MBP, and as to the extent and nature of any such research

activities.   Luna is an engineer employed by the Internal Revenue

Service in Dallas, Texas.   He visited the site of the jojoba

plantations in Yuma, Arizona, and inspected the growing jojoba.

He is qualified to testify as an expert in the instant cases as

to the matters set forth in his report.   Petitioners did not call

an expert witness on their behalf.

     In the report prepared with respect to the Yuma Mesa

partnership, Luna concluded that the activities conducted on the

130 acres controlled by Yuma Mesa between December 31, 1982, and

December 31, 1986 (plantation I), were aimed at the creation of a

mature jojoba farm and were not designed or carried out for the

purpose of acquiring information about jojoba that was unknown at

the time.   Luna found that few, if any, scientific procedures

were established for the conduct of the proposed research.     There

was no outline or timetable for completion of any proposed R&D

project.

     Luna concluded that investigation and evaluation of the

suitability of the climate in Yuma, Arizona, for raising jojoba

was not a research endeavor undertaken by Yuma Mesa.   If, in

fact, climatic conditions for growing jojoba had been a goal of
                               - 20 -

the research, there would have been no consideration given to

altering the climatic conditions at the plantation with wind

machines.   For a research project, Luna explained, the procedures

and conditions would have been followed to a conclusion so that

the researchers could learn from the outcome.    The attempt to

obtain financing to purchase wind machines reflected an attempt

to continue the commercial operation of the plantation as a

farming operation.

     Luna indicated that some of the projects or activities on

the 130-acre tract farmed for Yuma Mesa during the period in

question might have been conducted as research activities.    The

two areas of possible research activity were:    (1) Herbicide

testing; and (2) the effects of water conservation and fertilizer

utilization on jojoba.    Luna estimated that of the 130 acres

available for research activities, activities that might have

been conducted for research were only carried out on

approximately 14 acres.    The record does not establish whether

the studies in question were conducted entirely on the land

devoted to operations for Yuma Mesa.    Yuma Mesa did not provide

Luna with any documentation indicating amounts paid or costs

incurred by the partnership or its representatives for any of the

studies.

     In the report he prepared with respect to the Cactus Wren

partnership, Luna concluded that the activities performed on the
                                - 21 -

17.2 acres controlled by Cactus Wren (plantation II) were

predominately aimed at the creation of a mature jojoba farm and

were not for the purpose of acquiring information about jojoba

that was unknown at the time.    Luna found no substantial evidence

that any research was conducted.

     Peterson and others had predetermined that the jojoba

cultivated by Cactus Wren on plantation II would be grown using

the rooted cutting method.   The decision to use rooted cuttings

on plantation II applied already existing knowledge about jojoba

farming.

     Additionally, MBP provided Luna with no expense records

supporting an allocation of the contract fee ($164,057) among

qualifying and nonqualifying activities under section 174.

     In the FPAA's, respondent determined that Cactus Wren and

Yuma Mesa were not entitled to deductions claimed for tax

counseling fees and that Yuma Mesa was not entitled to a

deduction claimed for guaranteed payments to partners.

Petitioners presented no evidence on these issues at trial and

did not dispute respondent's determinations by oral argument or

on brief.   Accordingly, we have treated these issues as conceded

by petitioners.

                                OPINION

     This partnership proceeding is governed by the procedural

rules of the Tax Equity and Fiscal Responsibility Act of 1982

(TEFRA), Pub. L. 97-248, sec. 402(a), 96 Stat. 648, codified as
                                - 22 -

secs. 6221-6233.   Under section 6221, the tax treatment of

partnership items is determined at the partnership level.      We

conclude that Yuma Mesa and Cactus Wren are not entitled to

section 174(a) research and experimental expense deductions for

1982 and 1983 because petitioners did not directly or indirectly

engage in research or experimentation.   In addition, we hold that

both of the limited partnerships lacked a realistic prospect of

entering a trade or business.    Zink v. United States, 929 F.2d

1015, 1021 (5th Cir. 1991).

     This Court previously has addressed the deductibility of

purported research and development expenditures under section 174

by limited partnerships formed for the purported purpose of

engaging in agricultural research and development of the jojoba

plant.   Glassley v. Commissioner, T.C. Memo. 1996-206; Stankevich

v. Commissioner, T.C. Memo. 1992-458.    In the Glassley and

Stankevich cases, we held that the taxpayers were not entitled to

deductions for research and experimentation expenditures under

circumstances similar to those presented in these consolidated

cases.

     The evidence presented in these cases persuades us that the

R&D agreements before us were mere window dressing, designed and

entered into solely to decrease the cost of participation in the

jojoba farming venture for the limited partners through the

mechanism of a large upfront deduction for expenditures that in

actuality were capital contributions.    Glassley v. Commissioner,
                              - 23 -

supra; Stankevich v. Commissioner, supra.

A.   Research and Experimental Expenditures for 1982 and 1983

      Section 174 allows a taxpayer12 to elect to treat research

and experimental expenditures paid or incurred during the taxable

year "in connection with" the taxpayer's trade or business as

expenses which are not chargeable to capital account.   The

expenditures so treated are allowed as a deduction.   Treasury

regulations provide that the expenditures may be paid or incurred

for research or experimentation carried on by the taxpayer or by

another on the taxpayer's behalf.   Sec. 1.174-2(a), Income Tax

Regs.

      Petitioners contend that the expenditures here in issue

qualify under the statutory standard.   Respondent argues, first,

that the expenditures in issue were not "research and

experimental expenditures" and, secondly, that Yuma Mesa and

Cactus Wren had no realistic prospect of engaging in a trade or

business related to jojoba farming and could at most act as

passive investors because of the existence of exclusive licenses.

Accordingly, respondent concludes that petitioners did not pay or

incur "research or experimental expenditures" in connection with

their "trade or business."   We agree with respondent on both

counts.

      The term "research or experimental expenditures" as used in



12
     The "taxpayer" for this purpose is the partnership. Cf.
Campbell v. United States, 813 F.2d 694, 695-696 (5th Cir. 1987).
                              - 24 -

section 174 means "expenditures incurred in connection with the

taxpayer's trade or business which represent research and

development costs in the experimental or laboratory sense."    Sec.

1.174-2(a)(1), Income Tax Regs.   This regulation further

provides:

     The term [research or experimental expenditures]
     includes generally all such costs incident to the
     development of an experimental or pilot model, a plant
     process, a product, a formula, an invention, or similar
     property, and the improvement of already existing
     property of the type mentioned. The term does not
     include expenditures such as those for the ordinary
     testing or inspection of materials or products for
     quality control or those for efficiency surveys,
     management studies, consumer surveys, advertising or
     promotions. [Id.] * * *

     Respondent claims that the amounts paid to HTP and MBP by

Yuma Mesa and Cactus Wren do not fall within the purview of the

quoted regulation and are not deductible under section 174.

Respondent contends that the amounts expended by Yuma Mesa and

Cactus Wren were incurred only in connection with a farming

enterprise and that the objective of the limited partnerships was

to develop commercial plantations for the farming of jojoba

through the work of AI.   Respondent argues that the activities of

AI were, at most, field trials and more likely were simply

farming activities directed towards maximizing the potential

production of the jojoba plantations.   Moreover, respondent

contends that on plantation II no research whatsoever was

performed by AI.   Petitioners contend that AI, pursuant to its

management contract with HTP and MBP, conducted valid research or
                              - 25 -

experimentation regarding cultivation of the jojoba plant on

behalf of Yuma Mesa and Cactus Wren, and consequently, under

section 174(a)(1), Yuma Mesa and Cactus Wren are entitled to

deduct the contract fees paid HTP and MBP for such research or

experimentation.   Respondent's determinations are presumed

correct, and petitioners have the burden of proving otherwise.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     Attempts to farm jojoba commercially do not represent

research and development in the experimental or laboratory sense.

Glassley v. Commissioner, supra; Stankevich v. Commissioner,

supra.   AI attempted to develop jojoba plantations that would be

farmed for the oil seed.   The limited partners of Yuma Mesa and

Cactus Wren would realize income only through the sale of the

jojoba oil if the plantations had been successful.   AI furnished

only one status report on the progress of the purported research

and development on plantation I.   AI did not maintain a

laboratory on either plantation or adequately document any of its

purported research and development costs.

     We agree with respondent's expert witness that AI's actions

were no more than what any farmer would do in the ordinary course

of preparing to grow a crop for commercial harvesting.

Petitioners chose not to call an expert witness in this trial.

There is no evidence suggesting that AI's efforts would lead to

patentable technology or even know-how.   Additionally, we note

that Don Shooter, the farm manager for AI, did not testify for
                              - 26 -

petitioners concerning any purported research or experimental

work for petitioners.   A party's failure to introduce evidence

within his possession which, if true, would be favorable to him,

gives rise to the presumption that if produced it would be

unfavorable.   Wichita Terminal Elevator Co. v. Commissioner, 6

T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).     The

record shows that these cases are further examples of efforts by

promoters and investors in the early 1980's to reduce the cost of

commencing and engaging in the farming of jojoba by claiming,

inaccurately, that capital expenditures in jojoba plantations

might be treated as research or experimental expenditures for

purposes of claiming deductions under section 174.    Glassley v.

Commissioner, T.C. Memo. 1996-206; Stankevich v. Commissioner,

T.C. Memo. 1992-458.

     Since Yuma Mesa and Cactus Wren did not directly or

indirectly engage in research or experimentation, we hold that

they are not entitled to a deduction for these expenditures under

section 174.

B.   Requirement of a Trade or Business

     In addition, we hold that the activities of Yuma Mesa and

Cactus Wren did not constitute a trade or business.   To be

entitled to deductions for research and development expenditures,

a taxpayer need not be currently producing or selling any

product.   Snow v. Commissioner, 416 U.S. 500, 503-504 (1974);

Zink v. United States, 929 F.2d at 1021.   However, not every
                                - 27 -

expenditure having some relationship to research and

experimentation is deductible under section 174(a).    The Supreme

Court's decision in Snow v. Commissioner, supra, "makes it

important to determine whether the prospects for developing a new

product that will be exploited in a business of the taxpayer are

realistic".    Spellman v. Commissioner, 845 F.2d. 148, 149 (7th

Cir. 1988), affg. T.C. Memo. 1986-403.   Unless there is a

realistic prospect that the taxpayer will ultimately engage in a

trade or business that exploits the developed technology, a

research and experimental expenditure cannot be said to have been

paid or incurred "in connection with" a trade or business.

Harris v. Commissioner, 16 F.3d 75, 81 (5th Cir. 1994), affg.

T.C. Memo. 1990-80, supplemented by 99 T.C. 121 (1992); Zink v.

United States, supra at 1023; Spellman v. Commissioner, supra at

148-149; Diamond v. Commissioner, 92 T.C. 423, 439 (1989), affd.

930 F.2d 372 (4th Cir. 1991).

     The management of investments, however, is not a trade or

business, regardless of how extensive or complete the portfolio

or how much time is required to manage such investments.     Green

v. Commissioner, 83 T.C. 667, 689 (1984).   This Court and other

Courts have scrutinized claimed research and development

expenditures to distinguish those that are legitimate from those

that are merely designed to shelter the income of passive

investors.    See, e.g., Diamond v. Commissioner, supra; Levin v.

Commissioner, 87 T.C. 698 (1986), affd. 832 F.2d 403 (7th Cir.
                              - 28 -

1987); Green v. Commissioner, supra; Spellman v. Commissioner,

T.C. Memo. 1986-403, affd. 845 F.2d 148 (7th Cir. 1988).   The

controlling inquiry, where a partnership is claiming deductions

under section 174, is whether there is a realistic prospect that

the technology to be developed will be exploited in a trade or

business of the entity in question.    See Diamond v. Commissioner,

supra.   Mere legal entitlement to enter into a trade or business

does not satisfy this test.   Instead, "The legal entitlement must

be backed by a probability of the firm's going into business."

Levin v. Commissioner, 832 F.2d at 407.

     In making this determination, we consider such facts and

circumstances as the intentions of the parties to the research

and development contract, the amount of capitalization retained

by the partnership during the research and development contract

period, the exercise of control by the partnership over the

person or organization conducting the research and development,

the existence of an option to acquire the technology developed by

the organization conducting the research and development and the

likelihood of its exercise, the business activities of the

partnership during the years in question, and the business

experience of the partners.   See Glassley v. Commissioner, T.C.

Memo. 1996-206; Mach-Tech, Ltd. Partnership v. Commissioner, T.C.

Memo. 1994-225, affd. without published opinion 59 F.3d 1241 (5th

Cir. 1995); Stankevich v. Commissioner, T.C. Memo. 1992-458;

Stauber v. Commissioner, T.C. Memo. 1992-128.
                              - 29 -

     A taxpayer may be precluded from engaging in a trade or

business with respect to the developed technology if the taxpayer

disposes of all incidents of ownership in the technology by

granting an exclusive license to a third party in exchange for a

royalty interest.   Diamond v. Commissioner, supra at 438; Levin

v. Commissioner, 87 T.C. at 725-728; Green v. Commissioner, supra

at 689.   "It is the licensee, rather than the licensor, who earns

profits from the sale of the product; the licensor merely

collects royalties from the licensee.    Thus, by granting an

exclusive license, the licensor is deprived of control over the

manufacture, use and sale of the product, and the licensee is the

one engaged in the trade of business of exploiting the developed

technology."   Medical Mobility Ltd. Partnership I v.

Commissioner, T.C. Memo. 1993-428.     As a mere passive investor,

the partnership will not be entitled to a deduction under section

174(a) for research and experimental expenditures.      Zink v.

United States, supra at 1022-1023; Diamond v. Commissioner, supra

at 443.

     In Green v. Commissioner, supra, a partnership entered into

a research and development agreement under which it divested

itself of all ownership rights in the technology to be produced

under the agreement.   We held that the taxpayer's partnership

could not have engaged in a trade or business as it had disposed

of all of the incidents of ownership by assigning all its rights

in the technology to a third party.     Green v. Commissioner, supra
                                - 30 -

at 689.   "Following this assignment, the partnership's activities

were purely ministerial; the taxpayers were no more than mere

investors."     Diamond v. Commissioner, supra at 438.

     In Levin v. Commissioner, 87 T.C. at 727-728, we held that

the grant of an exclusive license foreclosed the possibility that

the licensor could be engaged in a trade or business in

connection with the licensed product, as the licensor was

deprived of control over the product.      "An entity with no control

over activities in which it invests is more properly classified

as an investor and cannot be engaged in a trade or business in

connection with those activities."       Diamond v. Commissioner,

supra at 443.

     In Stankevich v. Commissioner, supra, the limited

partnership entered into an exclusive license agreement whereby

the limited partnership granted the prime contractor licenses to

any technology resulting from the prime contractor's research and

development efforts.    As a royalty, the limited partnerships

received 50-percent profit interests in the jojoba crops grown on

the acreage allocated to the limited partnerships.       We held that

the prime contractor conducted no research and experimentation

but instead sought to farm commercially.      We further held that

the limited partnerships were not entitled to a deduction for

research and experimentation expenditures under section 174(a)

because the limited partnerships were not engaged directly or

indirectly in a trade or business because of the granting of the
                               - 31 -

exclusive licenses.    We see no difference between the situation

in Stankevich v. Commissioner, supra, and the facts presented in

the cases here under consideration.     See also Glassley v.

Commissioner, supra.

     In Diamond v. Commissioner, supra, the partnership granted

an option to a research contractor to acquire an exclusive

license to the new technology at some future time.    Because the

option could have been exercised for a relatively nominal amount,

we concluded that there was no realistic prospect that the

partnership would ever enter any trade or business relating to

the technology.   Id. at 440-441.

     The cases before us now involve the simultaneous execution

by the limited partnerships of an R&D agreement and an exclusive

license agreement.    Although executed a year apart, the R&D

agreements entered into by Yuma Mesa and Cactus Wren were

substantially identical.

     Section B, paragraph 5 of the R&D agreement entered into

between Yuma Mesa and HTP on December 31, 1982, stipulates in

part:

     All technology developed, whether or not capable of
     patent or trademark registration, shall be the sole
     property of Investor * * * [Yuma Mesa] and shall be the
     subject of the License Agreement being concurrently
     executed by the Investor * * * [Yuma Mesa] and Mesa
     Plantations, Inc.

     Section B, paragraph 5 of the R&D agreement entered into

between Cactus Wren and MBP on December 31, 1983, stipulates in

part:
                                - 32 -

     All technology developed, whether or not capable of
     patent or trademark registration, shall be the sole
     property of Investor * * * [Cactus Wren] and shall be
     the subject of the License Agreement being concurrently
     executed by the Investor * * * [Cactus Wren] and
     Townhill Equities, Inc.

At all times, Mesa and Townhill Equities, Inc., had identical

ownership.

     Section B, paragraph 1 of both of the R&D agreements further

provide that "The research to be performed shall be solely at the

direction of the Contractor * * * [HTP, MBP] and the Investor * *

* [Yuma Mesa, Cactus Wren] shall have no right of participation

therein."

     The exclusive license agreements executed by Yuma Mesa and

Cactus Wren were also identical.     On December 31, 1982, Yuma Mesa

executed an exclusive license with Mesa, granting Mesa

(Licensee), "the exclusive right to utilize the technology

developed for the account of the Licensor * * * [Yuma Mesa]" in

return for the payment by the Contractor/Licensee * * * [MBP] of

royalties based upon future sales.       Pursuant to the licensing

agreement, these "royalties shall be payable to Licensor * * *

[Yuma Mesa] based upon cumulative annual gross revenue from sales

as follows:

            (a) 0 to $242,100                 0.0%

             (b) $242,101 to $322,800         3.0%

             (c) $322,801 to $403,500        10.0%

             (d) $403,501 to $565,000        25.0%

             (e) $565,001 to $807,100        37.0%
                              - 33 -

          (f) Over $807,100              42.5%"

     It is clear from the words of the licensing agreement that

Yuma Mesa was not going to be actively involved in the

development of the jojoba plantation.   As paragraph 2 in section

A points out:

     Said agreement provides that upon the sole
     determination by Hilltop Plantations, Inc. as
     Contractor, that the seed and/or bean of the jojoba
     plants developed may be sold commercially, then and in
     that event commercial farming and marketing shall be
     conducted pursuant to this Agreement.

The licensing agreement also states "that this Agreement in no

way constitutes a partnership or a joint venture between Licensor

* * * [Yuma Mesa] and Licensee * * * [Mesa Plantations]."

     The license agreement entered into between Cactus Wren and

MBP, on December 31, 1983, gives MBP (Contractor/Licensee), "the

exclusive right to utilize the technology developed for the

account of the Licensor * * * [Cactus Wren]" in consideration of

the payment by the Contractor/Licensee * * * [MBP] of royalties

based upon future sales.   Pursuant to the licensing agreement,

these "royalties shall be payable to Licensor * * * [Cactus Wren]

based upon cumulative annual gross revenue from sales as follows:

          (a) 0 to $56,250                0.0%

          (b) $56,251 to $75,000          3.0%

          (c) $75,001 to $93,750         10.0%

          (d) $93,751 to $131,250        25.0%

          (e) $131,251 to $187,500       37.0%
                                - 34 -

          (f) Over $187,500               42.5%"

     It is evident from the words of the licensing agreement that

Cactus Wren was not going to be actively involved in the

development of the jojoba plantation.    As paragraph 2 in section

A points out:

     Said agreement provides that upon the sole
     determination by Mockingbird Plantations, Inc. as
     Contractor, that the seed and/or bean of the jojoba
     plants developed may be sold commercially, then and in
     that event commercial farming and marketing shall be
     conducted pursuant to this Agreement.

The licensing agreement also states "that this Agreement in no

way constitutes a partnership or a joint venture between Licensor

* * * [Cactus Wren] and Licensee * * * [MBP]."

     "A taxpayer that funds research by another party in return

for royalties is clearly no more than an investor making a

capital contribution to the trade or business of another."       LDL

Research and Development II, Ltd. v. Commissioner,       F.3d.

(10th Cir., Sept. 8, 1997), affg. T.C. Memo. 1995-172.    It is

clear that Yuma Mesa and Cactus Wren funded the "research

activities" of HTP and MBP with the expectation of royalties from

the sale of the jojoba beans.    As the farm manager for both

plantation I and II, AI is the only entity that appears to have

been engaged in a trade or business related to jojoba farming.

The actions of the general partners and the four initial

investors in the project, including irregular visits to the

plantation sites and sending letters and photographs that
                             - 35 -

reported on the status of the maturing jojoba plants, were

nothing more than the actions of interested investors keeping up

with their investment.

     Although the license agreements entered into by Yuma Mesa

and Cactus Wren nominally had different parties as licensees, the

licensees were controlled by the same four individuals. Yuma

Mesa's licensee, Mesa, was controlled by HTP's shareholders

Almand, Peterson, Damer, and Meinke.   Cactus Wren's licensee,

MBP, was also owned in equal shares by Almand, Peterson, Damer,

and Meinke.

     AI entered into a management agreement on December 31, 1982,

with Mesa to be the farm manager for plantation I.    On December

31, 1983, AI entered into a substantively identical management

agreement with Mesa to be the farm manager for plantation II.

Pursuant to these contracts the manager agreed:   (1) To develop

and plant the property as a jojoba plantation; and (2) to manage,

operate, and maintain the property as a jojoba plantation and to

engage in research with respect to jojoba cultivation.

     Included in the management agreement with Yuma Mesa for

plantation I is a budget for the initial year that allocates

$198,600 to development costs such as "clearing, demolition and

spraying * * * grade fields * * * ripping * * * discing * * *

seed jojoba * * * jojoba seed," among other things.   Based upon

this management contract, we conclude that AI performed all of

the physical work upon plantation I.
                              - 36 -

     Included in the management agreement with Cactus Wren for

plantation II is a budget for the initial year that allocates

$43,800 to the purchase and planting of cloned plant material and

$7,689 (for 7 months) to culturing costs, such as fertilizing,

pest control, weeding, and other ongoing farm activities.      Based

upon this management contract, we conclude that AI performed all

of the physical work upon plantation II.

     From the formation to the abandonment of the partnerships,

Yuma Mesa and Cactus Wren had no employees.    See Harris v.

Commissioner, 16 F.3d at 80 n.10.   By contrast, AI employed two

managers, Don and Kelly Shooter, and hired individuals to perform

the actual farm work on the plantation.    Additionally, AI had

established itself in the jojoba farming industry as a plantation

manager.   By 1986, AI was running approximately 10 jojoba

plantations, several which were planted prior to those of Yuma

Mesa and Cactus Wren.

     We do not accept the testimony of Peterson at trial that

Mesa "did all the things that are required to raise jojoba."

Although Mesa had been engaged as the research and development

subcontractor, petitioners presented no evidence that Mesa had

any employees or exercised any control over the activities on the

jojoba plantations.   From the evidence before us, it appears that

Mesa's role was to ensure that the money paid by Yuma Mesa to HTP

and by Cactus Wren to MBP for purported research and development

went back to the shareholders of Hilltop Ventures, later Townhill
                              - 37 -

Equities, Inc., as lease payments.     HTP, MBP, Hilltop Ventures,

and Townhill Equities, Inc., were owned and controlled by

identical parties--Almand, Peterson, Meinke, and Damer.

Additional amounts were paid over to AI in accordance with the

management agreements and budgets summarized above.

     The passive nature and limited activity of Yuma Mesa and

Cactus Wren, as well as their lack of control over all aspects of

the investment, plainly demonstrate that the general partners of

Yuma Mesa and Cactus Wren never intended that these partnerships

would enter into a trade or business.13    Neither Yuma Mesa nor

Cactus Wren was adequately capitalized by the general partners

for operation as a business in the long-term.    Both Yuma Mesa and

Cactus Wren had run out of capital by 1987 and were not able to

purchase the wind machines.   None of the general partners had the

expertise necessary to operate a jojoba plantation.    The

contractual arrangements between Yuma Mesa and HTP and between

Cactus Wren and MBP, in addition to Mesa, made the prospects

unrealistic that the partnerships would ever be capable of

entering into a trade or business with respect to any technology

that might be developed.   The actions of the general partners in


13
     As the Court of Appeals for the Fifth Circuit noted in
Harris v. Commissioner, 16 F.3d 75 (5th Cir. 1994), affg. T.C.
Memo. 1990-80, supplemented by 99 T.C. 121 (1992): [T]hose cases
in which a sec. 174 deduction was upheld may be distinguished by
one dispositive factor: In each of the cases allowing the
deduction, the entity that incurred the research expenses
actually managed and actually controlled the use or marketing of
the research. Id. at 79.
                              - 38 -

Yuma Mesa and Cactus Wren were wholly consistent with investor

activity, not the activity of people engaged in an active trade

or business.

     After reviewing the record in the instant cases, we agree

with respondent that Yuma Mesa and Cactus Wren did not pay the

contract fees for research or experimentation to be conducted by

HTP and MBP on behalf of the limited partnerships.    Rather, for

the reasons discussed above, we conclude that the moneys the

limited partnerships remitted to HTP and MBP for the putative

research or experimentation, in actuality, were paid for the

limited partners' right to participate in the jojoba farming

enterprise being operated by AI in Yuma, Arizona.    In our view

the R&D agreements were designed and entered into solely to

provide a mechanism to disguise the capital contributions of the

limited partners as currently deductible expenditures and thus

reduce the cost of their participation in the farming venture.

     Accordingly, we hold that petitioners did not incur

deductible losses for research or experimentation expenditures

under section 174.   Respondent is sustained on this issue.
                        - 39 -

To reflect the foregoing,


                        Decisions will be entered for

                    respondent.
