                           T.C. Memo. 1998-6



                      UNITED STATES TAX COURT



          UTAH JOJOBA I RESEARCH, WILLIAM G. KELLEN,
              TAX MATTERS PARTNER,1 Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7619-90.                       Filed January 5, 1998.



     Frederick R. Schumacher, for petitioner.

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



             MEMORANDUM FINDINGS OF FACT AND OPINION

     DAWSON, Judge:   This case was assigned to Special Trial

Judge Norman H. Wolfe pursuant to the provisions of section




1
     There are at present 18 other docketed cases that are bound
by stipulation by the outcome of this case.
                               - 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:    Utah Jojoba I Research (Utah I)

is a limited partnership organized under the laws of California.

The provisions of sections 6221-6233 (the TEFRA partnership

provisions)3 are applicable to Utah I.   By notice of final

partnership administrative adjustment (FPAA) respondent

determined the following adjustments to the partnership return of

income of Utah I:   (1) Disallowance of a claimed loss for 1982 in

the amount of $1,304,819, including $1,298,627 claimed as

qualified research and experimental expenditures under section

174; and (2) disallowance of a claimed loss of $50,482 for 1983.

William G. Kellen (Kellen), as tax matters partner (TMP), timely

filed a petition with this Court.

     We must decide whether the Utah I partnership is entitled to

the claimed deductions for losses for 1982 and 1983 and

particularly whether Utah I is entitled to treat amounts

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 -


allegedly paid or incurred for research and experimental

expenditures as deductible trade or business expenses.




                          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 generally found on the

periphery of the Sonora Desert.    While classified as a member of

the boxwood family, it is not closely related to any other plant.

.   The 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.    Jojoba oil is useful for a variety of

products, ranging from cosmetics to industrial lubricants.

       The ban in 1971 on the importation of sperm whale oil

stimulated an interest in the commercial production of jojoba

oil.    In 1978, an estimated 2,200 acres of jojoba were planted in

Arizona and California.    At that time, it had been estimated that

25,000 acres of jojoba would be sufficient to replace the sperm
                               - 4 -


whale oil requirements of the United States.   By 1982, the

planted jojoba acreage had increased more than 10 times to an

estimated 25,000 acres, and by 1986 an estimated 40,000 acres of

jojoba had been planted in Arizona, California, and Texas.

     Utah I entered into an agreement with U.S. Agri Research and

Development Corp. (U.S. Agri) that purported to provide for U.S.

Agri to furnish agricultural research and development services

with respect to the growing of jojoba on land in Desert Center,

California (the plantation).   Utah I engaged in no activity other

than to enter into the agreements described herein and transmit

payments to U.S. Agri.

1.   Utah Jojoba I Research

     When the petition was filed, the principal place of business

of Utah I was Cora, Wyoming.

     On December 27, 1982, Utah I was organized as a limited

partnership with a described purpose of conducting research and

development involving the jojoba plant.   Kellen served as both

the general partner and TMP of Utah I.    Under the accrual method

of accounting and pursuant to a claimed election under section

174, Utah I claimed losses of $1,304,819 for 1982, largely from

the deduction of $1,298,627 as research and experimental

expenses for the taxable year ending on December 31, 1982, and

also claimed losses of $50,482 for the taxable year ending
                                - 5 -


December 31, 1983.   However, no activity under the research and

development (R&D) agreement occurred prior to December 31, 1982.

     In 1982, Kellen worked primarily as an attorney and a bank

executive in the Fontana and Riverside areas of California.     In

October 1982, Kellen was introduced by Eugene Pace (Pace), a

former neighbor and casual business acquaintance, to Coordinated

Financial Services (CFS) of Salt Lake City, Utah.    CFS and Pace

represented a group of investors who were seeking someone to

serve as the general partner for a limited partnership with a

described purpose of conducting research and development of the

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

suggested to CFS that Kellen would be a suitable general partner

for the jojoba limited partnership.

     Prior to his formation of U.S. Agri, discussed infra, Pace

was a financial planner.   In 1968 Pace simultaneously formed

Gemini Financial Corp. (Gemini) and a brokerage/dealership called

GFCS, Inc.   Through Gemini, Pace marketed life insurance and

securities in various forms.    Gemini was also involved in the

promotion of syndications as tax-advantaged investments in the

form of limited partnerships.    Among the many syndications

organized by Gemini were those involving investments in an orange

grove, apartment units, shopping centers, and egg-laying hens.

     At Pace's suggestion, Kellen traveled to Salt Lake City,

Utah, to interview with members of CFS regarding the general
                               - 6 -


partner position.   In November 1982, CFS notified Kellen that he

had been selected to serve as the general partner of Utah I.

Shortly thereafter, CFS notified Kellen that the investing group

intended to form three additional jojoba limited partnerships and

asked Kellen if he would serve as the general partner for these

additional limited partnerships.   Kellen agreed and became the

general partner of four jojoba research and development limited

partnerships, including Utah I.    When he became general partner

in 1982, Kellen had no prior experience in the growing of jojoba.

At that time, Kellen's knowledge of jojoba was limited to

articles he read in National Geographic and his familiarity to

some extent with the experimental jojoba plantations located at

the University of California at Riverside.

     Kellen and Pace had known each other since 1975.   Then Pace

owned a 96-acre orange grove located across the street from

Kellen's residence in Riverside, California.   Pace wished to

develop the orange grove through a syndication.   After learning

that Kellen was a civil engineer as well as an attorney, Pace

engaged Kellen to assist him in subdividing the land.   Kellen

successfully completed the subdivision of Pace's land in

approximately 1979.   Pleased with Kellen's handling of the sale

of the orange grove, Pace remained in contact with Kellen after

the sale was completed.
                               - 7 -


     The next joint business activity by Kellen and Pace occurred

either in late 1979 or early 1980 when Pace asked Kellen for

assistance in locating desert property with a good water supply

that would be suitable for growing jojoba.   Kellen directed Pace

to land located in Desert Center and Blythe, California, which

had an unlimited water supply for agricultural purposes.   Since

1974 Kellen had been actively involved in efforts to develop the

land in this area agriculturally.   According to Kellen, he was

actively involved in the development of alfalfa, citrus, jojoba,

grapes, and asparagus.   Nevertheless, the private placement

memorandum used to promote Utah I characterized Kellen as having

"no previous experience" with respect to jojoba beans.   The

maximum amount of land that Kellen owned at any one time in the

Desert Center and Blythe areas was 4,000 to 6,000 acres.

     Pace was pleased with the characteristics of the land Kellen

showed him in Desert Center, California, and thought it would be

a good location for growing jojoba.    In 1980, the Sterling Trust,

which had been established by Pace, purchased 400 acres of

property in Desert Center, California.   The Sterling Trust was an

inter vivos trust in which Pace was both the grantor and the

beneficiary.   At trial, Pace was not able to recall the name of

the individual who sold the property to the Sterling Trust.

Kellen served and continues to serve as trustee of the Sterling

Trust.   Kellen also served as a director of U.S. Agri before he
                               - 8 -


became general partner of jojoba farming partnerships.   In 1981,

the Sterling Trust leased the 400 acres it owned to U.S. Agri

(described infra) for jojoba farming operations.   The 80 acres

later allocated to Utah I were included in the 400 acres leased

to U.S. Agri.

     Utah I was financed through a private placement, as

described infra.   The operation was conducted by U.S. Agri,

purportedly with management and supervision by Agri Futures, Inc.

     Kellen frequently made the 120-mile trip from his office to

Desert Center to inspect the land allocated to Utah I.   As

general partner, Kellen received quarterly progress reports in

the form of correspondence from Pace on behalf of U.S. Agri

regarding the progress on the jojoba plantation.   On October 23,

1983, Kellen forwarded one of the progress reports he received

from U.S. Agri regarding the growth of the jojoba plants to Utah

I's limited partners.   Although Kellen received additional

progress reports from Pace on behalf of U.S. Agri during 1984, he

did not forward any of these reports to the limited partners of

Utah I.   On February 14, 1985, Kellen forwarded two additional

progress reports from Pace on behalf of U.S. Agri to the limited

partners of Utah I.

     Pace believed that Utah I's research contract with U.S. Agri

terminated after 4 years, on approximately December 31, 1986.

However, by its literal terms, the R&D agreement expired upon
                               - 9 -


Utah I's execution of the license agreement described in

paragraph 10.a of the R&D agreement.   This license agreement was

executed by Kellen on December 31, 1982, concurrently with

Kellen's execution of the R&D agreement.   Kellen testified at

trial that he did not read the private placement memorandum for

Utah I, which included the R&D agreement and the license

agreement, before signing them on December 31, 1982, and that

after signing the documents he gave "No thought to the license

agreement whatsoever."

     By 1986, U.S. Agri had not been successful in developing a

method to "harden off" the jojoba plants cultured in the

laboratory and grown in a greenhouse test tube.    According to

Pace, the process of hardening off jojoba plants refers to the

technique of taking a jojoba plant grown in a greenhouse test

tube and successfully planting it in the ground.    As a result, a

high percentage of the cultured jojoba plants died after they

were planted in the ground.   In 1987, when Pace decided to close

U.S. Agri's laboratory and greenhouse and stop all research

activity, U.S. Agri was still experiencing a 90-percent failure

rate for the cultured jojoba plants transferred to the field.

Soon after, in late 1987, U.S. Agri integrated the 80 acres

allocated to Utah I with the rest of its commercial jojoba

farming operation.
                              - 10 -


     Kellen testified that passage of the Tax Reform Act of 1986,

which required passive investors to capitalize all preproduction

costs, ultimately contributed to the failure of Utah I.    Kellen

explained that "with the collapse, basically, of the tax

incentive for doing jojoba, we had to then go into some type of

other mode of operation to see if we couldn't make the venture

profitable."   In October 1991, Utah I was consolidated with 36

other limited partnerships under contract with U.S. Agri into one

large limited partnership, Jojoba Plantation Ltd.    The general

partners of the 37 limited partnerships believed that by

combining resources they could reduce costs and enable their

jojoba farming ventures to become profitable.     At the time of the

trial of this case, Jojoba Plantation Ltd. was in chapter 7

bankruptcy.

          a.   The Private Placement Memorandum

     Coordinated Financial Services (CFS) prepared the private

placement memorandum (the offering) and all other organizational

and contractual documents for Utah I, including the R&D agreement

and the license agreement.   Although Kellen, as general partner

of Utah I, properly executed the documents, he claims that he did

not carefully review any of the documents prepared by CFS before

subscriptions were taken for Utah I.   The offering, dated

November 10, 1982, provided for a maximum capitalization of

$2,968,000 consisting of 350 limited partnership units, at $8,480
                              - 11 -


per unit.   Each unit consisted of a cash downpayment of $2,500

and a non-interest-bearing promissory note in the principal

amount of $5,980 payable in 10 annual installments with an

acceleration provision in case of default.   Subscription

agreements, which included the promissory note, were signed by

each limited partner and obliged him to make these payments.

Kellen never took any action in a State or Federal court to

enforce the promissory notes against the limited partners of Utah

I who defaulted.   The offering was limited to investors with a

net worth (exclusive of home, furnishings, and automobiles) of

$150,000, or investors whose net worth was $50,000 (exclusive of

home, furnishings, and automobiles) and who anticipated that for

the taxable year of the investment they would have gross income

equal to $65,000, or taxable income, a portion of which, but for

tax-advantaged investments, would be subject to a Federal income

tax rate of 50 percent.   Each limited partner also was required

to execute a limited guaranty agreement in which he guaranteed a

proportionate share of partnership debt to U.S. Agri.   The Utah I

partnership was formed with subscriptions for 247 units for a

total capitalization of $2,094,560, which facilitated farming

operations on 80 acres of real property located in the environs

of Desert Center, California, for a period of approximately 4

years.
                                - 12 -


     According to the offering circular, Utah I was to be "formed

to undertake a comprehensive research and development program on

the plant Simmondsia Chinensis (Jojoba)," and, ultimately obtain

production from the plantation property allocated to Utah I.

The offering identified U.S. Agri as the contractor selected to

carry out the research and development program under an R&D

agreement.

     b.   U.S. Agri

     U.S. Agri was a Nevada corporation established by Pace on

November 7, 1979.     Prior to 1979, Pace was not familiar with

jojoba.   Pace was the sole shareholder of U.S. Agri and also

served as the chief executive officer.     Pace delayed activating

U.S. Agri until the summer of 1981 so he could learn more about

the jojoba business before committing to participation in the

business.    For 4 or 5 months in 1981, Kellen served as an officer

and director of U.S. Agri.

     U.S. Agri leased, with an option to buy, 1,306 acres of land

in Desert Center and Blythe, California.     U.S. Agri allocated 400

of those acres located in Desert Center to research and

development partnerships.     The other 906 acres were utilized for

U.S. Agri's commercial jojoba farming operations.     The 400 acres

that U.S. Agri allocated to research and development partnerships
                              - 13 -


were leased from the Sterling Trust.4   In 1981, U.S. Agri began

making leasehold payments to the Sterling Trust for this land,

including the 80 acres that Utah I would later comprise.

     U.S. Agri was only nominally capitalized before the summer

of 1981, and thereafter was capitalized with $200,000 cash

invested by Pace.   As part of the capitalization of U.S. Agri,

Pace also became obligated on a $150,000 note and deed of trust

for the initial 400 acres that had been purchased by the Sterling

Trust and leased to U.S. Agri.   Funds paid for subscriptions to

Utah I subsequently were used to pay for or reimburse U.S. Agri

for costs associated with tilling and leveling the land, planting

jojoba, purchasing and installing the irrigation system, and

otherwise developing Utah I's 80-acre jojoba plantation.

     In March 1982, U.S. Agri opened a laboratory and a

greenhouse in Riverside, California.    Pace alleges that the day-

to-day management of the greenhouse was handled by Pace's

parents.   Pace claims to have hired Dr. Prem Jauhar and Dr. Joyce

Clark to set up and run the laboratory.   Other technical

personnel Pace claims to have employed to perform research for

U.S. Agri in the lab and greenhouse include Dr. Meena Moses, Dr.

Fen Lin, Dr. Duncan Williams, and Dr. Steven Koenisberg.    None of

the above-named technical personnel from U.S. Agri testified at


4
     There is no information in the record regarding the
ownership of the remaining 906 acres of land leased by U.S. Agri.
                                - 14 -


the trial.   Additionally, no evidence was introduced at the trial

to substantiate Pace's testimony regarding their actual

employment by U.S. Agri.

     Sometime between 1979 and 1981, U.S. Agri allegedly entered

into a management contract with Agri Futures, Inc. (Agri

Futures), a California company.    Under this contract, Agri

Futures purportedly was to develop the 400 acres U.S. Agri leased

from the Sterling Trust, including the land allocated to Utah I,

into jojoba plantations.   Agri Futures was also known as American

Jojoba Industries.   U.S. Agri's management contract with Agri

Futures is not part of the record in this case.

     The sole shareholders of Agri Futures, Gordon Fisher and

Bill Rivers, also served as officers and directors of U.S. Agri.

As U.S. Agri's subcontractor, Agri Futures provided the physical

labor involved in the preparation of the land for farming jojoba

and the maintenance of the jojoba plantations.    Pursuant to its

management contract with U.S. Agri, Agri Futures purportedly

planted, maintained, and irrigated the jojoba on the land

allocated to Utah I.   Pace testified that employees of Agri

Futures performed all of the work for Utah I that was necessary

to follow the plan he developed for Utah I.    Funding for these

activities was provided by U.S. Agri pursuant to its arrangements

with Utah I, described infra.     No one from Agri Futures testified

at the trial.
                                - 15 -


     Throughout the entire time that Pace operated U.S. Agri, he

was a member of the International Jojoba Association.   As a

member of the International Jojoba Association, Pace participated

in the association's drive to increase the overall annual size of

the jojoba crop in order to have a readily available source of

supply at a reasonable yet profitable price.   These efforts may

have included the sharing of information regarding field tests

among growers of jojoba.

     In the late summer or early fall of 1982, U.S. Agri produced

a videotape primarily aimed at potential general partners for

jojoba limited partnerships that described jojoba as "liquid

gold" and "the industrial crop of the future".   Pace testified

that this videotape was distributed to 400-500 people in the

financial planning community.    Additionally, each general partner

of the 12 jojoba research and development limited partnerships

serviced by U.S. Agri received a copy of the videotape.

     According to Pace, his ultimate objective in establishing

U.S. Agri, the laboratory, and the greenhouse, in addition to

acquiring the 400 acres in Desert Center, was "to develop two or

three dozen super hybrid jojoba plants that could be cloned

and/or xeroxed, if you will, by virtue of the techniques

developed in the lab, for sale to other growers."   According to

Pace, the land in Desert Center was necessary in order to be able

to identify which of the jojoba plants cultured in the lab would
                                - 16 -


actually grow into superior plants that then could be sold to

other growers.    However, none of the work done in the laboratory

or greenhouse was specifically designated for Utah I.     U.S. Agri

did not allocate any of its losses from its laboratory and

greenhouse operations to Utah I.

     U.S. Agri's failure to develop a successful technique for

hardening off the jojoba plants cultured in the laboratory and

passage of the Tax Reform Act of 1986 forced Pace to close U.S.

Agri's laboratory and greenhouse in October or November 1987.

As a result, the 400 acres of land that U.S. Agri allegedly had

allocated to research and development, including the land

allocated to Utah I, was added to the 906 acres that U.S. Agri

already was operating as a commercial jojoba farming operation.

     By 1991, U.S. Agri serviced 37 different limited

partnerships that eventually merged into Jojoba Plantation Ltd.

Twelve of these limited partnerships were being serviced pursuant

to agreements similar to the agreement between Utah I and U.S.

Agri.

     c.    The Research and Development Agreement

        U.S. Agri executed an exclusive R&D agreement with Utah I on

December 31, 1982, for the stated purpose of "conducting research

and experimentation on the jojoba plant and developing the

technology resulting in the commercial cultivation of the jojoba

plant."     No other bids were considered for the role of prime
                               - 17 -


research contractor.   The R&D agreement, along with other

documents, was sent by CFS to Kellen at his law office on

December 31, 1982, in a last minute rush to execute and file the

documents before the end of the year.    Pursuant to directions

Kellen received from CFS, he notified the notary at his law

office to be on "standby" and waited for the courier to arrive

with the documents.    Upon the arrival of the courier, Kellen

quickly signed the documents and had them notarized before

returning them to the courier.

     The terms of the R&D agreement entered into between U.S.

Agri and Utah I specified that U.S. Agri was "to use its best

efforts to develop a jojoba plantation in the vicinity of Desert

Center, California, at a specific location to be selected by * *

* [U.S. Agri] to be used to conduct research on the

domestication, commercial cultivation, planting and irrigation

techniques, weed, disease and insect management, and harvesting

of the jojoba plant.   Said plantation to be eighty (80) acres."

The 80 acres was further described in the R&D agreement as

follows:

     The plantation will be located within the larger tract
     of land described as follows: the Southeast quarter of
     the Northwest quarter and the Southwest quarter of
     Section 16, Township 5 South, Range 16 East, San
     Bernardino Base and Meridan.

     Under the R&D agreement, Utah I agreed to pay U.S. Agri a

total of $1,298,627, plus interest, $423,428.52 of which was to
                               - 18 -


be paid with the execution of the R&D agreement.    Subsequent

installments of nine payments of $121,941 each, including

interest on the unpaid balance at the rate of 7 percent, were to

be paid annually starting on July 31, 1983.    The final sum of

$232,921 representing the balance of the payments at 7 percent

and 2 percent of deferred interest not previously paid was to be

paid on July 31, 1992.    The record does not include evidence

concerning actual payment of any of these amounts except for Utah

I's 1982 and 1983 tax returns and Pace's testimony that he

recovered the amounts he advanced to start U.S. Agri from Utah I

funds.

       The R&D agreement also specified that U.S. Agri was entitled

to "retain any and all amounts paid to it by the Partnership * *

* [Utah I], whether or not the R&D Program is successful and

accomplishes the results contemplated hereunder.    * * * [U.S.

Agri] does not guarantee that its work will be successful and the

Partnership * * * [Utah I] shall have no rights of refund."      The

R&D agreement further provided that "Any real property and

tangible personal property acquired or improved" by U.S. Agri in

connection with the research and development program was to

remain U.S. Agri's sole property and that "no ownership rights in

such property will be transferred to the partnership * * * [Utah

I]."    The R&D agreement also stated that no income from the

jojoba plantation was anticipated during the research and
                              - 19 -


development period.   If any income were generated during the R&D

period, it would "be divided eighty-five percent (85%) to the

Partnership * * * [Utah I] and fifteen percent (15%) to the

Contractor * * * [U.S. Agri]."

     As part of the R&D agreement, Utah I also had the option of

requiring U.S. Agri to enter into a license agreement that would

include the commercial exploitation of the jojoba plantation

assigned to it.   The option, which referred to U.S. Agri as the

contractor and Utah I as the partnership, was described as

follows:

     At such time as the Jojoba plantation on which the
     research and development is being conducted has reached
     a stage of commercial development, the Contractor * * *
     shall give the Partnership a written report to that
     effect and the Partnership will have the option to
     require the Contractor to enter into a License
     Agreement for the purpose of commercially exploiting
     the technology developed pursuant to this Agreement. *
     * * This option shall be solely at the discretion of
     the Partnership.

Execution of the license agreement by Utah I, pursuant to this

option, would result in the automatic termination of the R&D

agreement between Utah I and U.S. Agri according to the terms of

the R&D agreement.

     The R&D agreement gave Utah I the ownership of "any

inventions, discoveries, improvements, devices, designs,

apparatus, practices, processes, methods or products, * * *

whether patentable or not, made, developed, perfected, devised,

conceived" in the course of U.S. Agri's work for Utah I.   U.S.
                              - 20 -


Agri did not develop any proprietary technology with respect to

or for Utah I.   U.S. Agri did present four pages of an incomplete

patent application that had been prepared with respect to a

tissue culture process.    However, this application was never

filed or completed, nor did it concern Utah I.

     d.   The License Agreement

     Concurrently with the execution of the R&D agreement between

Utah I and U.S. Agri, on December 31, 1982, Kellen, on behalf of

Utah I, executed an exclusive license agreement with U.S. Agri.

The license agreement granted U.S. Agri for 40 years "the

exclusive right to utilize the technology developed for the

account of the Licensor * * * [Utah I]," in exchange for which "a

royalty shall be paid by Licensee * * * [U.S. Agri] to Licensor *

* * [Utah I]."   The amount of the royalty "shall be eighty-five

percent (85%) of all products produced on the Plantation and

intended to be sold or moved from the Plantation by the Licensee

* * * [U.S. Agri]."

     e.   The Amended Research and Development Agreement

     On February 4, 1983, Kellen on behalf of Utah I, and Pace on

behalf of U.S. Agri, executed an addendum to the original R&D

agreement that set forth a "Research Plan" regarding the 80-acre

plantation allocated to Utah I.   The stated objectives of the

amended research plan were:

     (1) to develop cultural information on how to manage
     Jojoba plantations in semi-arid regions of Southern
                               - 21 -


     California in terms of irrigation, fertilization and
     weed control treatment; (2) to compare the productivity
     of plots established with different genetic materials;
     (3) determine the variations, if any, as to plant
     response of different genetic materials in relation to
     #1 above and; (4) to develop sections of Jojoba with
     maturation, and above average seed size.

A chart containing a configuration of the field testing to be

completed on Utah I's plantation pursuant to the amended research

plan was attached.   Pursuant to the amended research plan, all of

Utah I's land was to be planted at one time.   In addition, the

amended research plan contained no provision for the repetition

of any of the purported experiments to average out the influence

of any uncontrollable factors such as the weather.

     To carry out the objectives of the amended research plan, 3

plots of 10 rows of jojoba seed each were to be divided for

purposes of comparing the use of "Roundup" and "Princep" as

herbicide treatments.   In 1983, both "Roundup" and "Princep" were

herbicides or weed killers generally available to the public for

farming purposes.    The amended research plan also provided for 6

subplots of 20 rows each, which would be subjected to various

irrigation and fertilization techniques.   The first two subplots

were to be irrigated at various levels throughout the growing

season, and no fertilizer would be applied to the subplots.    The

third and fourth subplots were to be irrigated in the same

fashion but fertilized with "Uran 32".   The fifth and sixth

subplots also were to be irrigated in the same fashion but
                                - 22 -


fertilized with "10340".    "Uran 32" and "10340" were fertilizers

generally available to the farming community in 1983.    The final

part of the amended research plan specified that 5 acres of the

80-acre parcel allocated to Utah I was to be divided into 4

subplots.    Each of the four subplots was to be planted with seed

collected and cataloged by U.S. Agri as to specific geographic

origin.    Once the jojoba plants had emerged, they were to be

irrigated at a specific rate.

       The record does not establish that the above-described

procedures ever were carried out.    Petitioner's business records

contain no formal compilation of research data or scientific

analysis completed for Utah I.    U.S. Agri's only records of the

work allegedly carried out on behalf of Utah I are 16 pages of

handwritten notes reflecting Pace's personal observations on the

growth of the jojoba plants from April 1983 through December

1985.    Pace's notes were made at irregular intervals and contain

no scientific data.    For example, in July 1983 Pace states in his

notes "Emergence is very good.    Continue everything exactly as it

is."    One year later in July 1984, Pace noted "1, 2 & 3 [a]ll

look good but weeds in one are quite a problem.    No observable

damage or losses in 2 or 3 but probably too soon to tell."      There

is no evidence that Agri Futures, as the farm manager for U.S.

Agri, prepared any reports regarding the status of the jojoba

being grown on land allocated to Utah I.
                              - 23 -


2.   The Expert--Levi Chen

     Levi Chen (Chen) testified for respondent as to whether any

research or experimentation activities were conducted pursuant to

the exclusive R&D agreement entered into between Utah I and U.S.

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

activities.   Chen is an engineer employed by the Internal Revenue

Service in Los Angeles, California.    He visited the site of the

jojoba plantation in Desert Center, California, and inspected the

growing jojoba in May 1986.   Chen also visited U.S. Agri's

laboratory and greenhouse in Riverside, California.   He is

qualified to testify as an expert in the instant case as to the

matters set forth in his report.   Petitioner did not call an

expert witness to testify.

     In the report he prepared with respect to the Utah I

partnership, Chen concluded that the activities conducted on the

80 acres controlled by Utah I between December 31, 1982, and

December 31, 1986, were irrigation, fertilization, and herbicide

field tests combined with efforts to select superior jojoba

plants for propagation.   The field tests were carried out using

commercially available herbicides, such as "Roundup" and

"Princep", and commercially available fertilizers, such as "Uran

32", and a "10-34-0"5 mixture in different combinations, which is


5
     The amended research plan refers to the fertilizer as simply
"10340".
                              - 24 -


a common farming practice.   Chen concluded that the activities

conducted by U.S. Agri on the land allocated to Utah I did not

constitute research and development and were merely farming

activities.   The field tests were not designed or carried out for

the purpose of acquiring information about jojoba that was

unknown at the time.   Chen found no substantial evidence that any

research was conducted.

     Chen found that few, if any, scientific procedures were

established for the conduct of the proposed research.    In Chen's

view, for the conclusion of a research project to be valid, the

experiment must be able to produce repeatable results, and Utah

I's research project produced no repeatable results.    Chen's

report elaborated:

     Experiments are planned to minimize the effects of
     uncontrollable factors such as weather. In botany this
     means that an experiment would have to be carried out
     on the same age plants over several years to average
     out the influence of the weather. Otherwise it would
     not be possible to determine if results were due to the
     experiment.

     The Partnership's Project was planted without any
     provision for the repetition of the experiments. The
     land was planted at once.

Staggered planting of the land is necessary so that the same age

plants from different years could be compared and conclusions

could be formed about the effectiveness of the various

procedures.   There is no evidence that staggered planting

occurred on Utah I.
                              - 25 -


     In preparing his expert report, Chen reviewed copies of the

quarterly progress reports Pace, on behalf of U.S. Agri,

submitted to Kellen, as general partner of Utah I, as required by

the original R&D agreement.   Although Chen found that the

progress reports contained some general statements about starting

an "experimental procedure", by mid-1986 the progress reports

contained no references to any possible research activities.

Generally, however, Chen concluded that the progress reports

submitted by U.S. Agri were written in the manner of general

farming reports containing information on the progress of Utah

I's jojoba crop.   The progress reports contained no discussion of

the different experiments as set forth in the amended research

plan, nor any description of how each plot was progressing

relative to others or a control plot.

     The handwritten notes Pace submitted were determined by Chen

to be inadequate for research purposes.   They contained no record

of weather conditions or growth measurements of the jojoba

plants.   Furthermore, the time intervals between Pace's written

observations were irregular and too far apart for Pace's notes to

be of any scientific value.

     Chen also determined that the plant selection portion of the

amended research plan was merely an application of existing

processes and techniques used to cull the best plants and was not

selective breeding.   Chen's report stated that U.S. Agri's
                              - 26 -


purported plan to breed the seeds from only one generation of

jojoba plants in an attempt to produce a jojoba plant with

superior attributes was nothing more than U.S. Agri practicing

culling.   Chen's report explained that U.S. Agri's activities

were not plant breeding.   Producing plants with consistently

superior attributes takes many generations in order to assure

that "the progenies would breed true."

     After touring U.S. Agri's laboratory and greenhouse in

Riverside, California, Chen concluded that the activities carried

out in the laboratory and greenhouse had not been contracted for

by Utah I.   The amended research plan of Utah I contains no

references to U.S. Agri's laboratory or greenhouse.   U.S. Agri

did not provide Chen with any of its expense records regarding

the contract fee it received from Utah I.

     On the basis of the foregoing, Chen concluded that in his

expert opinion "the partnership has not shown that it has done

anything but farming."

                              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

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

partnership items is determined at the partnership level.     We

conclude that Utah I is not entitled to a section 174(a) research
                                - 27 -


and experimental expense deduction for 1982 because it did not

directly or indirectly engage in research or experimentation.    In

addition, we hold that Utah I was not actively involved in a

trade or business and also lacked a realistic prospect of

entering a trade or business.    Nickeson v. Commissioner, 962 F.2d

973, 978 (10th Cir. 1992), affg. Brock v. Commissioner, T.C.

Memo. 1989-641; Zink v. United States, 929 F.2d 1015, 1021 (5th

Cir. 1991).   Therefore, Utah I is not entitled to any additional

deductions for 1982 and 1983 under section 162(a).

     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.   Cactus Wren Jojoba, Ltd. v. Commissioner, T.C. Memo.

1997-504; Glassley v. Commissioner, T.C. Memo. 1996-206;

Stankevich v. Commissioner, T.C. Memo. 1992-458.     In the Cactus

Wren Jojoba Ltd., Glassley, and Stankevich cases, we held that

the taxpayers were not entitled to deductions for research and

experimental expenditures under circumstances similar to those

presented in this case.

     The evidence presented in this case persuades us that the

R&D agreement before us was 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
                              - 28 -


mechanism of a large up-front deduction for expenditures that in

actuality were capital contributions.     Cactus Wren Jojoba, Ltd.

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

Stankevich v. Commissioner, supra.     Additionally, Utah I was

involved in neither the business of jojoba technology research

nor jojoba production.   At most, Utah I was a passive investor in

a farming venture from which it might have received a share of

any profits in the future.   Kellen, the general partner of Utah

I, admitted that he did not even read the private placement

memorandum for Utah I, which included the R&D agreement and the

license agreement, until preparing this case for trial.

A.   Research and Experimental Expenditures for 1982

     Section 174 allows a taxpayer6 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 that 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.




6
     The "taxpayer" for this purpose is the partnership. Cf.
Campbell v. United States, 813 F.2d 694, 695-696 (5th Cir. 1987).
                               - 29 -


     Petitioner contends 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 Utah I did not

exercise sufficient direction or control over U.S. Agri to be

actively involved in a trade or business in connection with

jojoba production or jojoba technology research.    Respondent also

argues that Utah I had no realistic prospect of engaging in a

trade or business related to jojoba farming and could at most act

as a passive investor because of the existence of the exclusive

license.    Accordingly, respondent concludes that petitioner did

not pay or incur "research or experimental expenditures" in

connection with a "trade or business".    We agree with respondent.

     The term "research or experimental expenditures" as used in

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,
                              - 30 -


     management studies, consumer surveys, advertising or
     promotions. * * *

     Respondent claims that the amounts paid to U.S. Agri by Utah

I in 1982 do not fall within the purview of the quoted regulation

and are not deductible under section 174.   Respondent contends

that the amounts expended by Utah I were payments in connection

with U.S. Agri's farming enterprise that had the commercial

production of jojoba as the sole or primary objective.

Furthermore, most of the amounts paid by Utah I to U.S. Agri were

allocable to land development or improvement.   Respondent argues

that the activities of U.S. Agri were, at most, field testing and

more likely were simply farming activities directed toward

maximizing the potential production of the jojoba plantations.

Moreover, respondent contends that no research whatsoever was

performed by U.S. Agri on behalf of Utah I.   Petitioner contends

that U.S. Agri conducted valid research or experimentation

regarding cultivation of the jojoba plant on behalf of Utah I

and, consequently, under section 174(a)(1), Utah I is entitled to

deduct the contract fees paid to U.S. Agri for such research or

experimentation.   The record in this case supports our conclusion

that respondent's determinations are correct, and that

petitioner's arguments to the contrary are without merit.

     Attempts to farm jojoba commercially do not represent

research and development in the experimental or laboratory sense.

Cactus Wren Jojoba, Ltd. v. Commissioner, supra; Glassley v.
                                - 31 -


Commissioner, supra; Stankevich v. Commissioner, supra.      U.S.

Agri attempted to develop a jojoba plantation that would be

farmed for the oil seed.   The limited partners of Utah I would

have realized income only through the sale of the jojoba oil if

the plantation had been successful.      The correspondence of Pace

to Kellen, introduced at trial as progress reports from U.S.

Agri, did not reflect any proprietary technology but contained

only a general description of the growth of the jojoba plants and

was replete with optimistic comments regarding future jojoba

production.   Before 1983, Pace had only limited knowledge of and

minimal background in jojoba.    Despite Pace's inexperience with

the jojoba plant, 16 pages of Pace's handwritten notes reflecting

his personal observations on the growth of the jojoba plants from

April 1983 through December 1985 were the only reports on the

purported jojoba field research introduced by petitioner at

trial.   U.S. Agri's laboratory and greenhouse were located in

Riverside, California, and not at the site of Utah I's plantation

in Desert Center, California.    Additionally, petitioner failed to

provide documentation of U.S. Agri's purported research and

development costs.

     We agree with respondent's expert witness that U.S. Agri's

actions were no more than what any farmer would do in the

ordinary course of preparing to grow a crop for commercial

harvesting.   The amended research plan of Utah I primarily
                              - 32 -


involved the application of commercially available herbicides,

such as Roundup and Princep, and commercially available

fertilizers such as Uran 32 and a 10-34-0 mixture applied with

varying levels of irrigation to the jojoba plants.    Application

of these commercial products to a large-scale production endeavor

as was attempted on the land allocated to Utah I is merely

testing of the sort normally conducted as part of agricultural

operations.   See sec. 1.174-2(a), Income Tax Regs.   Evidence

presented at trial, including the testimony of both Kellen and

Pace, indicates that they interpreted the activities being

performed on Utah I's plantation as field testing or field

trials.

     The record does not show that U.S. Agri's efforts on behalf

of Utah I would lead to patentable technology or even know-how.

Moreover, the record does not include proof that the partially

completed patent application prepared by U.S. Agri concerned work

performed as part of its R&D agreement with Utah I.    We note that

none of the allegedly highly qualified individuals supposedly

employed by U.S. Agri to conduct the purported research and

experimentation on behalf of petitioner testified at trial.

Additionally, we note that no one from Agri Futures testified at

trial regarding the nature of the work performed by their

employees on Utah I's plantation.   The record shows that this

case is another example of efforts by promoters and investors in
                                - 33 -


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.     Cactus Wren Jojoba, Ltd. v. Commissioner,

T.C. Memo. 1997-504; Glassley v. Commissioner, T.C. Memo. 1996-

206; Stankevich v. Commissioner, T.C. Memo. 1992-458.

     Furthermore, in this case, it is questionable whether Utah

I's liability under its R&D agreement with U.S. Agri ever became

fixed.     According to its terms, the R&D agreement Utah I entered

into with U.S. Agri on December 31, 1982, expired upon Utah I's

execution of the license agreement.7     Kellen, as general partner

of Utah I, extinguished Utah I's liability under the R&D

agreement by contemporaneously executing the license agreement

with the R&D agreement.    As an experienced attorney and bank

executive, Kellen was capable of reading and understanding the

details of the R&D agreement and the license agreement he

executed on behalf of Utah I.    Kellen showed a lack of concern


7
     Paragraph 11 of the R&D agreement states:

     11.    Terms of this Agreement

          This Agreement shall be effective as of the date
     hereof, and shall terminate upon the first to occur of
     the following:

          a. Upon the execution of the License Agreement
     referred to in Paragraph 10.a hereof;
                              - 34 -


about the details of the two agreements that he hastily signed on

December 31, 1982.   Utah I's liability under the R&D agreement

was extinguished by Kellen's concurrent execution of the license

agreement between Utah I and U.S. Agri.   Therefore, the record

here indicates that the amounts paid to U.S. Agri by Utah I were

not even paid pursuant to a valid R&D agreement but were passive

investments in a farming venture under which the investors'

potential return was to be in the form of royalty pursuant to a

licensing agreement.

     Since Utah I did not directly or indirectly engage in

research or experimentation, we hold that petitioner is 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 Utah I 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); LDL Research & Dev.

II, Ltd. v. Commissioner, 124 F.3d 1338 (10th Cir. 1997), affg.

T.C. Memo. 1995-172.   However, "the taxpayer must still be

engaged in a trade or business at some time, and we must still

determine, through an examination of the facts of each case,

whether the taxpayer's activities in connection with a product
                                   - 35 -


are sufficiently substantial and regular to constitute a trade or

business" for purposes of section 174.       Green v. Commissioner, 83

T.C. 667, 686-687 (1984); see also Levin v. Commissioner, 87 T.C.

698, 725 (1986), affd. 832 F.2d 403 (7th Cir. 1987).

       The controlling inquiry in determining whether an

expenditure under section 174 was made "in connection with" the

partnership's trade or business is whether the taxpayer is

"'actively involved in the * * * [research project] as a trade or

business.'"    LDL Research & Dev. II, Ltd. v. Commissioner, supra

at 1342 (quoting Nickeson v. Commissioner, 962 F.2d at 978).       On

the record of this case, Utah I has not satisfied the "active

involvement" test set forth above.

       To be actively involved in the research project as a trade

or business, Utah I must be more than a passive investor in the

activities of U.S. Agri.     Id.    To establish that expenses under

section 174 were in connection with their trade or business,

"taxpayers must show * * * that their activities were substantial

and regular enough to establish that they were actively involved

in the trade or business."     Nickeson v. Commissioner, supra at

978.    Even if this Court had found that Utah I had a fixed

liability under the R&D agreement, the activities of Kellen and

U.S. Agri on behalf of Utah I did not establish that Utah I was

actively involved in a trade or business involving jojoba

technology or jojoba production.       See, e.g., Zink v. United
                               - 36 -


States, 929 F.2d at 1021; see also Higgins v. Commissioner, 312

U.S. 212, 218 (1941).   Kellen testified that he did not even read

the private placement memorandum for Utah I until preparing for

the trial of this case.   Utah I's role was only to serve as a

vehicle for the injection of risk capital into U.S. Agri's jojoba

farming operation.   Utah I was a passive investor in a farming

venture.

     Utah I's actions following the execution of the R&D

agreement were ministerial only.   As general partner, Kellen was

not active in pursuing the affairs of Utah I.   CFS and Pace

identified the investors for Utah I.    Kellen testified that CFS

prepared the private placement memorandum and all related

documents for Utah I.   Kellen simply signed all of the documents

placed before him without any analysis or independent evaluation.

Kellen did not regularly relay U.S. Agri's quarterly progress

reports, in the form of correspondence from Pace, to Utah I's

limited partners.    Kellen never met with the limited partners and

made no effort to enforce the obligations of the limited partners

who defaulted on their promissory notes.   Although Kellen claims

to have "frequently" visited Utah I's plantation, the actual

number of times he visited the plantation was never established.

Additionally, under both the original R&D agreement and the

amended research plan, as well as the licensing agreement, U.S.

Agri enjoyed complete discretion and control over any research
                                - 37 -


and development as well as farming activities on the 80 acres

allocated to Utah I.

     We also hold that Utah I had no realistic prospect of

entering into a trade or business with regard to the technology

that was to be developed by U.S. Agri.   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 the taxpayer can show that

there is a realistic prospect that he 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 the investments.    Green v.

Commissioner, supra at 688-689.    This Court and other courts have

scrutinized claimed research and development expenditures to
                              - 38 -


differentiate those that are legitimate from those that are

merely designed to shelter the income of passive investors.     See,

e.g., Spellman v. Commissioner, supra; Diamond v. Commissioner,

supra; Levin v. Commissioner, supra; Green v. Commissioner,

supra.   For an investing partnership successfully to claim

research and experimental deductions, there must be a realistic

prospect that the technology to be developed will be exploited in

a trade or business of the partnership claiming deductions under

section 174.   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 Cactus Wren Jojoba, Ltd. v.
                                - 39 -


Commissioner, T.C. Memo. 1997-504; 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.

     The grant of an exclusive license to exploit technology

prior to commencement of research and development may preclude a

licensor from engaging in a trade or business with respect to the

technology.     Spellman v. Commissioner, supra; Levin v.

Commissioner, 87 T.C. at 725-728; Green v. Commissioner, 83 T.C.

667 (1984).

     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 or business of
     exploiting the developed technology. [Medical Mobility Ltd.
     Partnership I v. Commissioner, T.C. Memo. 1993-428.]

As a mere passive investor, the licensor will not be entitled to

a deduction under section 174(a) for research and experimental

expenditures.     Nickeson v. Commissioner, 962 F.2d at 978; Zink v.

United States, 929 F.2d 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
                              - 40 -


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.     Id. 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 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.

     In Cactus Wren Jojoba, Ltd. v. Commissioner, supra, and

Stankevich v. Commissioner, supra, the limited partnership in
                              - 41 -


each case 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 each

received specified percentages of the profit interests in the

jojoba crops grown on the acreage allocated to the limited

partnerships for research purposes.    We held that the limited

partnerships were not entitled to a deduction for research and

experimental 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 exclusive

licenses.   We see no difference between the situations in Cactus

Wren Jojoba, Ltd. v. Commissioner, supra, and Stankevich v.

Commissioner, supra, and the facts presented in the case at bar.

See also Glassley v. Commissioner, supra.

     The case before us now involves the simultaneous execution

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

license agreement with a term of 40 years.    Additionally, the R&D

agreement terminated upon execution of the license agreement.

     Section 5 of the R&D agreement entered into between Utah I

and U.S. Agri provides in part:

     The property rights in and to all inventions,
     discoveries, improvements, devices, designs, apparatus,
     practices, processes, methods, or products (herein
     individually or collectively called "Inventions"),
     whether patentable or not, made, developed, perfected,
     devised, conceived, either solely or jointly with
                             - 42 -


     others, under the terms of this Agreement in the course
     of its Contractor's * * * [U.S. Agri's] work for the
     Partnership, * * * [Utah I] or any Inventions so made
     at any time which is an improvement on any invention
     covered by a patent application or patent acquired by
     the Partnership * * * [Utah I] shall be the sole and
     exclusive property of the Partnership * * * [Utah I].

     Section 10 of the R&D agreement granted Utah I an option,

exercisable after receipt of a written report from U.S. Agri,

that the plantation was ready for commercial development:

     At such time as the Jojoba plantation on which the
     research and development is being conducted has reached
     a stage of commercial development, the Contractor * * *
     [U.S. Agri] * * * shall give the Partnership * * *
     [Utah I] a written report to that effect and the
     Partnership * * * [Utah I] will have the option to
     require the Contractor * * * [U.S. Agri] to enter into
     a License Agreement for the purpose of commercially
     exploiting the technology developed pursuant to this
     Agreement. The License Agreement, if the Partnership *
     * * [Utah I] so elects, shall be in the form of the
     License Agreement attached hereto and made a part of
     this Agreement. This option shall be solely at the
     discretion of the Partnership * * * [Utah I].

In section A, paragraph 3 of the license agreement attached to

the R&D agreement, the "technology" is described as "written

reports delivered by the Licensee * * * [U.S. Agri] to Licensor *

* * [Utah I] during the term of the Research and Development

Agreement, all of which, taken together in the aggregate, will

comprise the technology and shall remain the sole property of the

Licensor * * * [Utah I]."

     Section B, paragraph 1 of the license agreement granted U.S.

Agri the exclusive right to utilize the technology:
                             - 43 -


     During the term hereof, Licensee * * * [U.S. Agri]
     shall have the exclusive right to utilize the
     technology developed for the account of the Licensor *
     * * [Utah I], and said technology shall be applied to
     the benefit of the parties on the Jojoba plantation * *
     * upon which the research and development has been
     conducted for the purpose of developing said
     technology.

Section B, paragraph 2 of the license agreement provides that

"The license granted hereby shall be exclusive."   Utah I

relinquished all of its rights to the plantation, retaining only

its nominal ownership of the technology, subject to the license,

in section B, paragraph 4 of the license agreement:

     Licensor * * * [Utah I] specifically disclaims any
     right, title, or interest in or to the Jojoba
     plantation on which the said technology will be
     developed and its sole asset is and shall be the
     technology for which the * * * royalty shall be paid.

Section B, paragraph 5 of the license agreement granted U.S. Agri

the exclusive license for a period of 40 years.

     According to the terms of the license agreement, Utah I

granted U.S. Agri the exclusive right to utilize the technology

developed for Utah I for 40 years in return for payments from

U.S. Agri of royalties of "eighty-five percent (85%) of all

products produced on the Plantation and intended to be sold or

moved from the Plantation by Licensee * * * [U.S. Agri]."

Section B, paragraph 6 of the licensing agreement also states

"that this Agreement in no way constitutes a partnership or a

joint venture between Licensor * * * [Utah I] and Licensee * * *

[U.S. Agri]."
                               - 44 -


     Kellen exercised Utah I's option under the R&D agreement on

December 31, 1982, when he signed the license agreement.   There

is no evidence in the record that any useful technology ever was

developed by U.S. Agri for Utah I under the terms of the R&D

agreement.    However, even if any technology had been developed,

under the terms of the license agreement, the licensor, Utah I,

relinquished any control over the technology for a 40-year

period.

     Utah I's election, contemporaneous with its execution of the

R&D agreement, to convey the "right to utilize the technology

developed" to U.S. Agri exclusively for a 40-year period reflects

the passive nature of Utah I's investment.    Additionally, it is

evident from the words of the R&D agreement that Utah I was not

going to be actively involved in the development of the jojoba

plantation.   As section 2 of the R&D agreement states:

     The Partnership * * * [Utah I] hereby engages
     Contractor * * * [U.S. Agri] to conduct the R&D Program
     and Contractor * * * [U.S. Agri] accepts such
     engagement hereunder and agrees to use its best efforts
     to develop a Jojoba plantation in the vicinity of
     Desert Center, California, at a specific location to be
     selected by Contractor * * * [U.S. Agri] to be used to
     conduct research on the domestication, commercial
     cultivation, planting and irrigation techniques, weed,
     disease and insect management and harvesting of the
     Jojoba plant. Said plantation to be eighty (80)acres.

It is unlikely that Kellen ever intended Utah I to enter into a

trade or business.   The contractual arrangements between Utah I

and U.S. Agri made the prospects unrealistic that Utah I would
                              - 45 -


ever be capable of entering into a trade or business with respect

to any technology that might be developed.    Under the terms of

the license agreement, Utah I was deprived of control over any

technology U.S. Agri might have developed.8   Kellen's actions

were consistent with investor activity and not the activity of a

person engaged in a trade or business.

     "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 & Dev. II, Ltd. v. Commissioner, 124 F.3d at 1346.      It

is clear that Utah I funded alleged "research activities" of U.S.

Agri with the expectation of royalties from the sale of the

jojoba beans.   The promotional videotape prepared by Pace, and

distributed to potential investors in jojoba limited partnerships

serviced by U.S. Agri, heavily emphasized the potential for a

high rate of return from an investment in "liquid gold" or

jojoba.

     As the contractor for Utah I, U.S. Agri was the only entity

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


8
     As the Court of Appeals for the Fifth Circuit noted in
Harris v. Commissioner, 16 F.3d 75,79 (5th Cir. 1994), affg. T.C.
Memo. 1990-80, supplemented by 99 T.C. 121 (1992): "those cases
in which a section 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".
                                - 46 -


testified at trial that U.S. Agri was operating commercial jojoba

farms on 906 acres of land in Desert Center and Blythe,

California, in addition to the 400 acres U.S. Agri had allegedly

set aside for R&D partnerships focused on jojoba.     Respondent's

expert witness, Chen, visited U.S. Agri's greenhouse and

laboratory in Riverside, California.     The actions of Kellen,

including irregular visits to the plantation site and forwarding

three of U.S. Agri's progress reports on the status of the

maturing jojoba plants to the limited partners of Utah I, were

merely the actions of an interested investor keeping up with his

investment.   There is no evidence that Kellen ever inspected U.S.

Agri's laboratory or greenhouse.

     There is no evidence before this Court regarding the details

of U.S. Agri's operating budget other than testimony from Pace

that none of U.S. Agri's losses were allocated to Utah I.

     Utah I had no employees.    See Harris v. Commissioner, 16

F.3d at 80 n.10.   Petitioner presented no evidence that Utah I

exercised any control over the activity on the jojoba plantation.

The evidence before us establishes that Utah I's role was to

distribute the money invested by the limited partners to U.S.

Agri pursuant to agreement.     U.S. Agri then used these funds to

finance activities on the 80-acre plantation site, including

planting the jojoba, tilling and leveling the land, and

installing the irrigation system.    These funds were also used by
                              - 47 -


U.S. Agri to make lease payments to the Sterling Trust.

Additionally, funds from investor subscriptions in Utah I went to

reimburse Pace or U.S. Agri for any developmental expenses

incurred on the plantation prior to the incorporation of Utah I.

     Utah I was not adequately capitalized for operation as a

business in the long term, as evidenced by Kellen's decision in

1991 to consolidate Utah I with 36 other jojoba limited

partnerships under contract with U.S. Agri into 1 large limited

partnership, Jojoba Plantation Ltd.    Kellen and the other general

partners hoped that the creation of one large limited partnership

would enable them to reduce the costs of farming jojoba.    By

1991, Jojoba Plantation was in chapter 7 bankruptcy.   Kellen made

no attempt to pursue any of the limited partners who defaulted on

their promissory notes to Utah I.

     On the record in the instant case, we agree with respondent

that Utah I did not pay the contract fees for research or

experimentation to be conducted by U.S. Agri on behalf of the

limited partnership.   Rather, for the reasons discussed above, we

conclude that the moneys the limited partnership remitted to Utah

I for the putative research or experimentation, in actuality,

were paid for the limited partners' right to participate as

passive investors in the jojoba farming enterprise being operated

by U.S. Agri in Desert Center, California.   In our view, the R&D

agreement was designed and entered into solely to provide a
                              - 48 -


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 Utah I is not entitled to deduct

its losses for research or experimentation expenditures under

section 174.   Additionally, because the activities of Utah I did

not constitute a trade or business, Utah I is not entitled to

deduct its losses in 1982 and 1983 as ordinary and necessary

business expenses under section 162(a).    Respondent is sustained

on these issues.

     To reflect the foregoing,


                                       Decision will be entered

                                 for respondent.
