                         T.C. Memo. 1997-448



                       UNITED STATES TAX COURT



           DHARMA ENTERPRISES, Petitioner v. COMMISSIONER
                   OF INTERNAL REVENUE, Respondent


     Docket No. 16756-95.                 Filed September 30, 1997.


     Charles W. Tuckman, Richard A. Saffir, and Robert C.

Alexander, for petitioner.

     James P. Thurston, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:    Respondent determined deficiencies in

petitioner's Federal income tax and accuracy-related penalties

under section 6662(a)1 for taxable years ending May 31 as

follows:


     1
       Unless otherwise indicated, all section and subchapter
references are to the Internal Revenue Code in effect for the
years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                   - 2 -


     Year             Deficiency                    Penalty
     1991              $209,006                     $41,801
     1992               192,075                      38,415
     1993               204,804                      40,961


     After concessions, the issues for consideration are:

(1) Whether the royalties paid to Dharma Mudranalaya for certain

intangible assets were reasonable in amount, (2) whether

petitioner is entitled to deduct net operating loss carryovers in

taxable years 1991 and 1993, (3) whether petitioner must increase

gross sales by $7,095 in taxable year 1992, and (4) whether

petitioner is liable for a section 6662(a) accuracy-related

penalty for each of the years in issue.

                          FINDINGS OF FACT

     Petitioner had its principal place of business in Oakland,

California, at the time the petition in this case was filed.

Petitioner operates a sheet-fed, lithographic commercial printing

business and provides typesetting, prepress, printing, and

binding services.   Petitioner also prints religious calendars,

postcards, and greeting cards through its Amber Lotus division.

     Petitioner claimed deductions under section 162(a) for the

payments to Dharma Mudranalaya (DM), a related entity, pursuant

to a license agreement for certain intangible assets in taxable

years ending May 31 as follows:

               Year                        Deduction Claimed
               1989                            $648,000
               1990                             785,000
               1991                             680,817
               1992                             854,840
               1993                             788,189
                               - 3 -


     Deductions claimed by petitioner in 1989 and 1990 produced

net operating losses (NOL’s) of $55,918 and $26,854,

respectively, which petitioner carried forward to 1991.

Similarly, petitioner claimed deductions in 1992 that resulted in

an NOL of $4,957, and petitioner carried forward the NOL to 1993.

Respondent disallowed the deductions as in excess of fair market

royalties for the licensed assets.     Petitioner reported taxable

income for the taxable years in issue of:

               Year                    Taxable Income
               1991                       $200,338
               1992                        (4,957)
               1993                        115,160

     Petitioner was incorporated in June 1987 as a nonprofit

mutual benefit corporation under the nonprofit mutual benefit

corporation law of the State of California.     Cal. Corp. Code sec.

7110 (West 1990).   It is a taxable subchapter C corporation for

Federal income tax purposes but has not issued any capital stock.

Petitioner's profits are to be used for a common purpose of its

members, who do not personally benefit from its profits.

Petitioner's articles of incorporation provide that petitioner

was formed "to contribute financially and in other ways to the

activities and welfare of non-profit organizations dedicated to

the transmission and preservation of the Buddha Dharma".    Despite

petitioner's stated purpose, petitioner has not made a charitable

contribution to a Buddhist organization since its inception.    A

secondary purpose of petitioner is to provide a work environment

in which to practice Buddhist principles.
                               - 4 -


     Petitioner is part of a network of organizations established

under the leadership of Tarthang Tulku (Tulku), a Buddhist lama

with active lineage of the Nyingma school of Tibetan Buddhism.

The organizations are dedicated to the preservation of Tibetan

Buddhism and include, among others:    (1) DM, (2) the Tibetan

Nyingma Meditation Center (Meditation Center), (3) the Nyingma

Institute in Berkeley, California, and a branch campus in

Boulder, Colorado, and (4) Nyingma Centers Corp. (collectively

Nyingma organizations or Dharma organizations).    Individuals

associated with these organizations are referred to as the

Nyingma community; i.e., individuals who practice and/or are

interested in the teachings of the Nyingma school of Tibetan

Buddhism.

     Tulku has adapted Tibetan Buddhist teachings for the West.

The Nyingma community refers to the practice of Buddhist

teachings, or Dharma, in the West as "skillful means".    In 1978,

Tulku wrote a book titled Skillful Means, which describes the

practice of Buddhist teachings in everyday life.    Skillful means,

as taught by Tulku, involves work as a spiritual practice with

certain spiritual value.   The book suggests that the application

of Buddhist principles enables individuals to become more

successful in their work, which makes work more satisfying and

meaningful.   The Nyingma Institute offers classes in skillful

means.

     DM prints and publishes rare Tibetan Buddhist texts and art.

DM's goals are to preserve traditional Tibetan Buddhist texts, to
                                - 5 -


transmit Buddhist teachings in the West, and to provide a work

setting in which to practice Buddhist teachings.    DM was a

section 501(c)(3) organization for Federal tax purposes from

December 1, 1987 to November 30, 1992.    From its inception in

1975 to 1985, DM was also engaged in the commercial printing

business.    In 1985, employees of DM who were members of the

Nyingma community formed Skillful Means Enterprises, also known

as Skillful Means Press (SMP), to take over DM's commercial

printing business, and DM ceased its commercial printing

operations.    Most of SMP's employees were members of the Nyingma

community.    DM provided a startup loan and rented printing

equipment and building facilities to SMP.    DM intended that SMP

would not own any assets.    DM also licensed the right to use

certain intangible assets, including the name "skillful means",

to SMP in exchange for royalties.

     A member of the Nyingma community, Arnaud Maitland

(Maitland), formed petitioner in June 1987 to provide binding

services to SMP.    Maitland earned a master’s degree from the

Nyingma Institute and served as its dean from 1980 to spring

1987, first at its Boulder campus and then in Berkeley.    Maitland

has taught classes at the Nyingma Institute, including classes in

skillful means.    He lived at the Nyingma Institute for rent of

$200 per month.    Maitland was petitioner's chief executive

officer.

     One month after petitioner's incorporation, in July 1987, DM

notified SMP that its license and rental agreements would
                                - 6 -


terminate in March 1988.    DM terminated the agreements in part

because SMP had been behind on the royalty payments since its

inception.    DM terminated SMP's license even though SMP had

become a profitable business and was growing rapidly.      In 1987,

SMP had over $2.8 million in gross sales.      Petitioner's ability

to take over SMP's printing business also instigated DM's

decision to terminate SMP's license.

     DM immediately entered into negotiations with petitioner for

the license of intangible assets and the sale of printing

equipment.    DM did not contact any other party regarding the

license.   Maitland represented petitioner in the license

negotiations.    Jack Petranker (Petranker) negotiated the license

agreement for DM.    Petranker was a director and officer of DM and

replaced Maitland as dean of the Nyingma Institute.      Petranker,

who had a law degree, prepared and filed the articles of

incorporation for petitioner and signed as petitioner's sole

incorporator.    Petranker is not involved in petitioner's business

operations.    Petranker also lent petitioner startup capital.     In

March 1988, petitioner owed over $70,000 to Petranker.

     When he formed petitioner, Maitland did not have any

experience in the printing industry.      Maitland began working at

SMP as a production manager, without compensation, in July 1987

to learn about the printing business.      SMP allowed Maitland to

work for it despite the fact that DM planned to enter into a

license agreement with petitioner.      Maitland relied on SMP's

business plans to determine petitioner's expected profits and did
                                 - 7 -


not prepare his own business plans.      Maitland also examined SMP's

financial information and met with SMP's customers and suppliers

and with industry experts to determine SMP's production capacity

and profitability.   SMP also trained petitioner's newly hired

employees.    Several months after SMP provided this assistance to

petitioner, a merger of petitioner and SMP was proposed.

     The merger occurred upon the termination of SMP's license

and rental agreements with DM.    Petitioner remained as the

surviving corporation.   All of SMP's members became members of

petitioner, and three became directors of petitioner.     In

addition, the majority of SMP's employees began working for

petitioner.   Petitioner took over SMP's printing business and

completed SMP's work in progress.    Pursuant to the merger

agreement, petitioner assumed all of SMP's assets and

liabilities, including a $70,000 loan from Petranker.

     Petitioner and DM entered into a sales agreement for the

printing equipment in November 1987 and a license agreement in

December 1987 to become effective at the termination of SMP's

license and rental agreement.    The parties amended the license

agreement on two occasions.2    First, they amended the license in

1989 to list the licensed assets and clarify the terms of the

original license agreement.    Second, they amended the license in


     2
        The stipulation of facts provides that the license
agreement was amended on three dates: June 1, 1989, Jan. 25,
1990, and Feb. 1, 1990. The Jan. 25, 1990, and Feb. 1, 1990,
amendments are similar in substantive terms, and both reduce the
royalty payments in equal amounts. For our convenience in this
opinion, we refer to the Jan. 25, 1990, and Feb. 1, 1990,
amendments as one amendment.
                                - 8 -


1990 to reduce the amount of the royalty payments.    When

petitioner and DM amended the license agreement, they were

represented by the same attorney who worked for the various

Nyingma organizations.

     The license agreement, as amended, granted to petitioner the

right to use the name "Dharma" and the trade names "Dharma

Enterprises", "Skillful Means Press", "Amber Lotus", and

"Dharmart Designs".    Tulku personally approved petitioner's use

of "Dharma" in its name.    DM has not registered any of these

trade names or the name Dharma as trademarks with either the

Federal or State government.    The license provides that

petitioner's Dharma name identifies it as an approved Dharma

organization.   Members of the Nyingma community and the Nyingma

organizations recognize petitioner as a Dharma organization.

Petitioner also licenses a moon/cloud logo, which DM designed at

petitioner's request.

     Pursuant to the amended license agreement, petitioner

received the right to "Certain proprietary Know-How, including

DM's expertise, [and] management techniques * * * for achieving

increased production and efficiency with a minimal workforce" and

the right to market this management technique.    Petitioner

referred to this licensed asset as skillful means management

technique (SMMT).3    SMMT involves the application of Dharma



     3
        Use of "skillful means management technique" and SMMT
does not express any decision with regard to DM's proprietary
interests in the materials pertaining to Buddhist principles
given to petitioner or the value of those materials.
                                - 9 -


principles in a business setting and is derived from the

principles set forth in the 1978 "Skillful Means" book.

Petitioner refers to "Skillful Means" as a general introduction

to the practice of Dharma and the licensed SMMT as an advanced

version.    SMMT focuses on three distinct aspects of human nature

to make work more successful and more satisfying:    Awareness,

concentration, and energy.    Employees record their level of each

of these three resources, such as low, medium, or high, during

different times of the workday.    Then they graph the results in

order to determine which of the three resources supports their

work activity, their state of mind, and their ability to

communicate and cooperate with coworkers at the different periods

of the day.    Employees engage in this exercise to become more

productive and efficient in their work.    In addition, they

attempt to determine the amount of time and energy wasted during

work hours from thinking about things unrelated to their jobs.

       Petitioner hired employees who were interested in practicing

Buddhist principles in a commercial work setting and who wanted

to work for a company whose profits were used to preserve Tibetan

Buddhist texts and art.    Approximately 30 percent of petitioner's

75 employees practiced SMMT in their work (Nyingma employees).

Petitioner's Nyingma employees did not have prior experience in

the printing business, except for the employees who had worked at

SMP.    Nyingma employees had practiced skillful means, or Buddhist

teachings, in previous jobs, read Tulku's "Skillful Means", and

taken skillful means classes at the Nyingma Institute before
                                - 10 -


coming to work for petitioner.    Petitioner also hired employees

with printing experience who did not practice Tibetan Buddhist

teachings at work (non-Nyingma employees).

     DM provided manuals and essays on SMMT to petitioner and

consulted with petitioner regarding the practice of SMMT by

petitioner's employees.    Petitioner held weekly classes on SMMT

for its Nyingma employees.    At the classes,   Nyingma employees

discussed their own experiences with SMMT in their work.     Nyingma

employees also participated in individual discussions with each

other regarding their work experiences.    Petitioner and the

Nyingma Institute subsidized the costs of classes that Nyingma

employees took at the Nyingma Institute.    Petitioner did not

distribute the SMMT manuals that it received from DM to

nonmanagerial personnel.    It did hand out SMMT pamphlets and

essays to Nyingma employees during class.    Nyingma employees were

asked not to photocopy the materials and were required to return

them at the end of the class.

     Petitioner paid its Nyingma employees significantly less

than it paid non-Nyingma employees with similar responsibilities.

Nyingma employees generally made less than $5 per hour, while

non-Nyingma employees made from $15 to $25 per hour.     The wages

of petitioner's Nyingma employees were below the average wage of

nonunion employees in the printing industry in Northern

California.   Nyingma employees worked at least 60 hours per week,

while non-Nyingma employees worked 40 hours a week.     Also,

Nyingma employees had low absenteeism and low turnover as
                               - 11 -


compared with non-Nyingma employees.    Many of the Nyingma

employees lived at the various Nyingma organizations.    Petitioner

estimated that it saved over $500,000 a year in labor costs

because of Nyingma employees' below-market wages and efficiency.

     During the years in issue, SMMT was continually being

developed and revised.   Petitioner contributed to these revisions

by sharing its experiences with the use of SMMT.    Tulku wrote

some of the SMMT materials.    Maitland wrote an article about his

experiences with SMMT that became part of the SMMT materials

given to petitioner under the license.    In 1994, DM published

"Mastering Successful Work", written by Tulku, as a sequel to the

1978 "Skillful Means".   "Mastering Successful Work" is related to

SMMT and is based on the SMMT materials transmitted to petitioner

under the license agreement.   Members of the Nyingma

organizations, other than petitioner, also applied Dharma in

their work.   For example, Maitland practiced Dharma principles as

dean of the Nyingma Institute, and employees of SMP had also

practiced skillful means, which SMP had licensed from DM.     SMMT

materials have been given to at least one other Nyingma

organization which did not have a license agreement with DM or

pay either petitioner or DM for use of the materials.    During the

years in issue, petitioner did not market SMMT.    In 1995,

petitioner held a 5-day seminar on SMMT, earning $7,500.

     As part of the 1990 amendment to the license agreement, DM

also agreed not to compete with petitioner in the commercial

printing industry for 5 years and to refer commercial customers
                                - 12 -


to petitioner.   In addition, the amended license agreement

granted to petitioner the right to two computer software

programs, including software that prepares price estimates for

printing jobs.   An employee/director of petitioner updated the

computer software as necessary.    Petitioner did not solicit bids

for the computer software from other companies before licensing

it from DM.

     Petitioner also received a list of DM's commercial customers

from its 1985 business.    Neither the original license agreement

nor the subsequent amendments specifically identified a customer

list as a licensed asset.    However, both parties understood and

intended that the agreement conveyed to petitioner the right to

use DM's customer list.    DM had previously licensed the same

customer list to SMP in 1985.    When SMP's license terminated,

DM's 1985 customer list reverted to DM pursuant to the license

agreement.

     Petitioner was formed without any capital contribution from

its members and primarily relied on DM, other Nyingma

organizations, and members of the Nyingma community for

financing.    DM and another Nyingma entity financed petitioner's

purchase of the printing equipment.      Petitioner borrowed money

from the Nyingma Institute and from various individuals,

including Petranker, for startup capital.      Petitioner also

received favorable credit terms from suppliers that enabled it to

start business with capital contributions from its members.      In

1989, DM and the Meditation Center financed petitioner's purchase
                                - 13 -


of a $1 million, four-color printing press.    The purchase of the

four-color press prompted petitioner and DM to amend the license

agreement to reduce the amount of the royalty payments.    An

unrelated bank denied petitioner a loan for this press unless the

royalty payments were decreased.    Although petitioner borrowed

the money from DM and the Meditation Center instead of the bank,

petitioner and DM still decreased the royalties to ensure that

petitioner would be able to repay the loan.

     Tulku serves as honorary chairman of petitioner's board of

directors.   Petitioner views Tulku's chairmanship as a public

endorsement of petitioner as a Nyingma organization.    Petitioner

paid the following amounts to Tulku for his chairmanship in

taxable years ending May 31:

                 Year                Compensation
                 1991                  $25,440
                 1992                   26,140
                 1993                   26,640

Tulku is not active in petitioner's business operations and has

never attended a board meeting.    However, Tulku frequently

discusses SMMT with Maitland.

     During the years in issue, all of petitioner's directors

were associated with, had studied and practiced, or were

interested in, the Nyingma school of Tibetan Buddhism and the

general Buddhist teachings known as Dharma.    In addition, most of

petitioner's directors lived at the various Nyingma

organizations.   DM and petitioner had two common directors.    Two

of petitioner's directors, one of which was Maitland, served as

directors of the Nyingma Centers Corp., an umbrella corporation
                                - 14 -


which oversees and coordinates the activities of the various

Nyingma organizations.   Two directors, including Maitland, had

taught skillful means classes at the Nyingma Institute and served

as its dean.

     Petitioner's market for its commercial printing business,

with the exception of the Amber Lotus division, encompassed the

greater San Francisco Bay Area.    It did not advertise its

commercial printing business and primarily relied on customer

referrals and cold calls to obtain new customers.    Petitioner had

a reputation as a high-quality, low-priced printer that provided

good customer service.   Petitioner's Amber Lotus division

advertised through a variety of methods.    The Amber Lotus

division accounted for approximately 7 percent of petitioner's

gross sales during the years in issue.    Amber Lotus was started

by DM in 1986.

     In taxable year 1991, petitioner reported gross sales of

$6,239,139 on its tax return.    Respondent determined that

petitioner underreported its gross sales by $8,301.    Petitioner

concedes an increase in its gross sales of $1,206.    Petitioner

reported gross sales of $7,095 less than reflected on its books

and records because petitioner double counted sales on its books

and records by this amount.   Petitioner had issued two invoices

to a customer for the same print job and recorded both invoices

as gross sales on its books and records.    The customer paid both

invoices and then informed petitioner about the overbilling.
                              - 15 -


Petitioner issued a credit to the customer in the amount of

$7,095 to adjust for the prior overbilling.

                              OPINION

     The primary issue for our consideration is whether

petitioner's royalty payments to DM were reasonable in amount.

To the extent petitioner's payments to DM are disallowed as

royalties, petitioner argues that it is entitled to deduct the

payments under section 162 as payments to a charitable

organization in expectation of commensurate financial benefit.

     Taxpayers are entitled to deduct royalty expenses incurred

in carrying on a trade or business that are reasonable in amount

under section 162(a)(3).   Sierra Club Inc. v. Commissioner, 86

F.3d 1526, 1531 (9th Cir. 1996), affg. in part and revg. in part

103 T.C. 307 (1994); Surloff v. Commissioner, 81 T.C. 210, 232

(1983); Differential Steel Car Co. v. Commissioner, 16 T.C. 413,

423 (1951).   Reasonableness is a question of fact to be

determined from all the facts and circumstances.   Petitioner

bears the burden of proving the reasonableness of royalty

payments.   Rule 142(a); New Colonial Ice Co. v. Helvering, 292

U.S. 435, 440 (1934).   Respondent agrees that petitioner may

deduct the royalty payments under section 162(a)(3) to the extent

they were reasonable.

     Royalty payments between related parties require special

scrutiny to determine whether they are reasonable in amount.

Royalty payments are reasonable if an unrelated third party

dealing at arm's length would have agreed to the payments.
                              - 16 -


Merritt v. Commissioner, 39 T.C. 257, 270 (1962), revd. on

another issue sub nom. Paragon Jewel Coal Co. v. Commissioner,

330 F.2d 161 (4th Cir. 1964), revd. 380 U.S. 624 (1965); Belknap

v. Commissioner, T.C. Memo. 1989-210.   Typically two parties are

considered closely related if they have common owners.    However,

petitioner is a nonprofit corporation under the laws of the State

of California and does not have shareholders.   Nevertheless, we

find that petitioner is closely related to DM for Federal income

tax purposes and that petitioner and DM did not negotiate the

amount of the royalty payments at arm's length.

     Petitioner and DM have a common purpose, to preserve Tibetan

Buddhism.   Petitioner's payments to DM satisfy its stated purpose

to financially support the Buddha Dharma.   Petitioner has a tax

incentive to characterize the payments to DM as fully deductible

royalties as opposed to charitable contributions for which

deductions are limited under section 170.   DM also benefits from

the relationship because it received the profits from a

commercial printing business while minimizing the risks to its

tax-exempt status.   Ordinarily, a common purpose between two

charitable or religious organizations will not result in a

finding that the two entities are closely related for tax

purposes, subjecting their transactions to close scrutiny by a

court with regard to the reasonableness of transactions between

them.   Based on the facts and circumstances of this case, we find

that petitioner and DM are closely related parties and used that

relationship to claim excessive deductions that are not justified
                                - 17 -


by business reality.   In such circumstances, it is appropriate

for us to consider the relationship between a religious

organization and its members.

     Maitland, petitioner's founder and chief executive officer,

had a longstanding, close relationship with the various Nyingma

organizations.   Maitland studied at the Nyingma Institute, served

as its dean, taught classes there, and lived at the school.

Maitland was also a director of Nyingma Centers Corp.    In

addition, Petranker, who negotiated the license for DM, had ties

to petitioner.   He prepared its articles of incorporation and

acted as the sole incorporator.    Petranker also lent startup

capital to petitioner so that its founders did not have to make

capital investments.   In 1988, petitioner owed over $70,000 to

Petranker.   Moreover, all of petitioner's nine directors were

members of the Nyingma community and subscribed to the teachings

of the Nyingma school of Tibetan Buddhism.    Petitioner’s

directors also served as directors of the other Nyingma

organizations, lived in the Nyingma housing, were deans of the

Nyingma Institute, and had taught courses there.    In addition,

Maitland recruited employees for petitioner from the classes he

taught at the Institute.

     The manner in which petitioner and DM conducted the license

negotiations raises suspicion and leads to a finding that arm's-

length bargaining did not exist.    Maitland did not prepare a

business plan and relied on plans and sales projections prepared

by SMP.   Petitioner received valuable assets from DM, including
                              - 18 -


trade names and trademarks, SMMT, the right to commercially

market SMMT, two computer software programs, DM’s customer list,

and a covenant not to compete.   However, there is no evidence

that petitioner attempted to derive a monetary value for the

licensed assets before entering into negotiations and simply

wanted to pay the same amount of royalties that SMP paid.

Maitland admitted that he was careless in drafting and reviewing

the written agreement.   He omitted the most important licensed

asset, SMMT, from the original license agreement and omitted the

customer list from both the original and amended agreements.      DM

did not contact any interested third party to discuss possible

licensing of the intangible assets.    In addition, petitioner and

DM were represented by the same attorney when they amended the

license agreement.

     The financing that petitioner received from the various

Nyingma organizations also indicates that a close relationship

existed between petitioner and DM as two entities within a larger

network of Nyingma organizations.   The Nyingma Institute lent

money to petitioner.   DM along with other Nyingma organizations

financed petitioner's initial purchase of printing equipment and

the purchase of the four-color press in 1989.

     Petitioner took SMP's place within the Nyingma network, and

SMP assisted petitioner in entering into the printing business.

SMP permitted Maitland to work there and also trained

petitioner's newly hired employees.    Maitland relied on SMP's

business plans and profit projections rather than preparing his
                               - 19 -


own.    SMP provided this assistance before the merger with

petitioner was proposed and with the knowledge that petitioner

would be taking over its terminated license.    SMP was run by

members of the Nyingma community and controlled by DM and the

other Nyingma organizations.    The assistance that petitioner

received from SMP supports a finding of a close relationship

between DM and petitioner.

       Petitioner wants to appear as an entity independent from DM

with its own desire to earn a profit.    However, petitioner

constantly paid the majority of its after-tax profits to DM and

even sustained an after-tax loss during one of the years in

issue.    Moreover, after petitioner paid its profits to DM, it had

to go to DM and another Nyingma organization for financing when

it needed a new printing press to stay competitive in the

industry.    Petitioner dedicated its profits to benefit Buddhist

culture and traditions.    It made no difference to petitioner

whether it paid large or small royalties to DM because the

profits given to DM would be used for these purposes.    Because of

the close relationship between petitioner and DM, we find that

the license agreement was not the result of arm's-length

bargaining.

       The determination of the amount of reasonable royalties in

this case requires two lines of inquiry:    (1) What assets did

petitioner license from DM, and (2) what is the value of the

licensed assets?    Both parties presented expert witnesses

regarding the value of the license agreement.    We are not bound
                                - 20 -


by the opinion of any expert witness when the opinion is contrary

to our judgment.     Chiu v. Commissioner, 84 T.C. 722, 734 (1985).

We may accept or reject expert testimony as we find appropriate.

Helvering v. National Grocery Co., 304 U.S. 282, 294-295 (1938);

Seagate Tech., Inc. & Consol. Subs. v. Commissioner, 102 T.C.

149, 186 (1994).

     Petitioner's expert report was prepared by Peterson

Consulting L.L.C. (Peterson Consulting).    Mr. Philip Rowley

(Rowley), a vice president of Peterson Consulting, testified at

trial regarding his company's valuation of the license.    Peterson

Consulting applied an incremental profit method to value the

license.    For the valuation, Peterson Consulting included the

following assets as being part of the license agreement:      Trade

names, trademarks and logos, SMMT, the right to market SMMT,

computer software, and certification as a Dharma/Nyingma

organization.    Peterson Consulting also considered DM's covenant

not to compete in its evaluation of the license.

     Under the incremental profits method, Peterson Consulting

estimated petitioner's profits with and without the licensed

assets.    It attributed the difference between the two, or

incremental profits, to the value of the licensed assets.     It

adjusted the value for applicable taxes and discounted it to

present value.     Peterson Consulting valued petitioner's business,

as of the 1990 amendment, with the license at $5,611,392 and

without the license at $439,970 for incremental profits from the
                               - 21 -


license of $5,171,422.    It determined that the pretax, present

value of the license was $1,411,480 per year.

     Peterson Consulting considered SMMT to be the majority of

the license's value and identified below-market labor costs and

employee productivity as two benefits of SMMT.    To measure the

value of SMMT, Peterson Consulting compared petitioner's total

labor costs as a percentage of its gross sales with the industry

average labor costs-to-gross sales for sheet-fed printers with

similar gross sales from the Printing Industries of America, Inc.

(PIA) annual reports.    In 1989 and 1990, petitioner's labor

costs-to-gross sales ratio was 21.36 percent, while the PIA

industry ratio was 38.38 percent.    According to Peterson

Consulting, the 17.02-percent difference produced labor cost

savings for petitioner in 1989 and 1990 of $1,548,714.      Peterson

Consulting did not include payroll taxes, worker compensation

insurance costs, and vacation wages as part of petitioner's labor

costs and overstated petitioner's labor costs savings.

     Peterson Consulting also assessed the value of SMMT by

comparing petitioner's sales-to-assets ratio with the PIA

industry average.   According to Peterson Consulting, the sales-

to-assets ratio measured petitioner's productivity.    It

determined that petitioner's gross sales-to-net fixed assets in

1989 and 1990 was 9.44 percent, and the PIA industry average was

7.11 percent.   It concluded that the higher sales-to-assets ratio

meant that petitioner had an additional $2.33 in sales for each

dollar that it spent on fixed assets compared to its average
                                - 22 -


competitor.   Peterson Consulting attributed $603,855 of

petitioner's incremental profits to petitioner's improved

productivity from using SMMT.    However, Peterson Consulting

excluded over 50 percent of the cost of the four-color press

acquired in 1989 in petitioner's sales-to-assets ratio.     This

omission overstates petitioner's productivity and is a

significant error in the valuation.      Moreover, there is evidence

in the record that petitioner was inefficient and disorganized as

compared with other printing companies.

     Peterson Consulting also applied this inaccurate sales-to-

assets ratio to project petitioner's sales without the license,

further distorting the license's value.     It reasoned that

petitioner would not have obtained financing for the press

without the license agreement.    There is no factual basis to

support this conclusion.    When petitioner applied for a bank loan

for the four-color press, it was told that it had to reduce the

amount of the royalties to qualify for a loan.     In that regard,

without the payment of the royalties to DM, petitioner would have

had above-average profitability, which makes it reasonable to

conclude that it would have been able to obtain independent

financing.    The financing from DM is attributable to their close

relationship and is not an asset transferred pursuant to the

license agreement.

     In general, the methodology of petitioner's expert report

makes it unreliable for valuation in this case.     Peterson
                               - 23 -


Consulting improperly attributed the entire amount of

petitioner's labor costs savings to the assets licensed from DM.

Petitioner had lower labor costs than its competitor because

Nyingma employees' work ethic and dedication to the teachings and

preservation of Buddhism made them willing to work for long hours

at below-market wages.   Petitioner contends that it was able to

attract low-paid Nyingma employees only because it licensed SMMT

and the Dharma name from DM.    Nyingma employees valued work as a

spiritual practice before working for petitioner.    Petitioner's

Nyingma employees had experience with the various Nyingma

organizations, had studied Buddhist teachings, and read Tulku's

"Skillful Means".   They had practiced skillful means in prior

jobs and had taken, and even taught, classes on that subject at

the Nyingma Institute.

     Most likely, Nyingma employees would not have worked for

petitioner if it was not a Nyingma organization and associated

with Buddhism.   However, we are not convinced that petitioner

would be a Dharma organization only if it paid royalties to DM.

Petitioner's stated purpose was to support Buddhism.    The active

lineage referred to in the license amendment was through Tulku,

not DM, and Tulku was the leader of the Nyingma community.   Tulku

publicly endorsed petitioner as a Dharma organization and served

as honorary board chairman.    Tulku personally approved

petitioner's use of the Dharma name.    Petitioner was viewed as an

authorized Nyingma organization by members of the Nyingma

community, in part, because of its association with Tulku.   Tulku
                               - 24 -


was paid over $25,000 a year, independent of the royalties to DM,

for his public support of petitioner.      These facts reduce the

purported value of the licensed Dharma name.

     Petitioner argues that without the claimed royalty

deductions, its profitability would be substantially higher than

the industry average.    However, profitability is not an accurate

measure of fair market royalties in this case because

petitioner's above-average profits were not attributable to the

license.   Petitioner's expert did not specifically value the

individual assets licensed under the agreement or provide a

method to allocate the proposed value among the various assets.

Also, Peterson Consulting determined the profits generated by the

licensed assets and did not determine a fair market royalty for

the license.   Thus, its expert report is only of limited utility

in our decision.

     We find the method of valuation provided in respondent's

expert report to be more reliable than petitioner's methodology.

Consequently, we focus our attention on respondent's report.

Respondent's expert report was prepared by American Valuation

Group, Inc. (AVG).   Dr. Herbert Spiro (Spiro), AVG's president,

testified regarding the valuation.      In general, AVG valued the

same assets considered by Peterson Consulting.      AVG's expert

report included the following assets and fair market royalties

for the licensed assets:

     Licensed Assets                   1991      1992      1993
     SMMT                            $20,400   $21,012   $21,642
     Computer software                 4,000     4,000     4,000
     Marketing of SMMT                 1,000     1,030     1,061
                               - 25 -


    Trademarks and trade names        52,396    57,636       62,823
    Customer list                    106,433    86,098       69,117
    Right to financing                 -0-        -0-          -0-
    Covenant noncompete                -0-        -0-          -0-
                                                         1
          Total                      184,229   169,776    158,643
     1
      The expert report contained a mathematical error of $1
that we have corrected.

AVG used three methods of valuation to determine reasonable

royalty payments pursuant to the license agreement:      (1) A

replacement cost method, (2) a market comparison method, and (3)

an income method.    The method that AVG used depended on the

particular asset being valued.

     First, AVG used the replacement cost method to value

petitioner's right to use and commercially market SMMT and the

computer software.    AVG valued SMMT based on the $1,500 cost of a

4-week class at the Nyingma Institute for petitioner's eight

Nyingma managers for a total cost of $10,050 in 1990.        AVG added

$10,400 for consultations provided by DM, mostly with Tulku,

regarding the application of SMMT.      It assumed a 1-hour

consultation each week and a consulting fee of $200 per hour.

AVG discounted the value of SMMT licensed by petitioner as

compared with the courses now offered by the Nyingma Institute

because SMMT was being developed and revised during the years in

issue.

     Respondent argues that the license agreement, as amended,

did not give petitioner the right to offer SMMT instruction to

nonmanagerial employees.    The license agreement did not expressly

mention SMMT and conveyed the right to DM's expertise and
                               - 26 -


management techniques to improve worker productivity and

efficiency.   We interpret the license agreement to include the

right to offer SMMT to both managerial and nonmanagerial

employees.    Calling SMMT a management technique does not mean

that it is only available to managerial employees.    The purpose

of SMMT is to increase productivity and efficiency in the work

force.   Such improvements would not be possible without providing

instruction on SMMT to nonmanagerial employees.    Petitioner held

weekly SMMT classes for all Nyingma employees.    The fact that

petitioner only distributed the SMMT manuals to management does

not require the conclusion that SMMT was not available to

nonmanagerial employees.    We find that petitioner licensed SMMT

for use by its managerial and nonmanagerial employees.    Thus,

respondent's expert report understated the value of SMMT.

     The wide availability of teachings of skillful means reduces

the value of SMMT.   Petitioner attempts to distinguish between

skillful means, which Tulku described in his book with the same

name, and the licensed asset, which petitioner refers to as SMMT.

Petitioner's witnesses repeatedly referred to the book "Skillful

Means" as a general introduction to the practice of Dharma and

SMMT as an advanced version.    However, petitioner has failed to

specifically identify the differences between skillful means and

SMMT that would enable us to assess the credibility of its

witnesses' testimony.   Based on the record before us, we believe

that petitioner created an artificial distinction between
                               - 27 -


skillful means and SMMT to justify substantial transfers of its

profits to DM, a closely related entity.

     Moreover, we do not agree with petitioner's contention that

SMMT is a proprietary trade secret that justifies the exorbitant

royalties that petitioner paid to DM.    "Mastering Successful

Work", which DM published in 1994, relates to SMMT and sells for

$14.95.   The preface of the book states that it is based on

materials that petitioner received pursuant to the license

agreement.   Petitioner denies that "Mastering Successful Work"

reveals any of the allegedly proprietary SMMT materials.

However, the testimony of petitioner's witness with regard to

this issue is not credible.    Moreover, the Nyingma Institute

offers skillful means classes, and DM published a book relating

to skillful means in 1978.    Nevertheless, we find that

petitioner's license of SMMT does support the payment of some

royalties to DM.

     We accept the general methodology of respondent's expert in

valuing SMMT.   Respondent's expert, Dr. Spiro, valued SMMT based

on the tuition for classes at the Nyingma Institute.    Respondent

argues that SMMT had little value because Nyingma workers valued

work as a spiritual practice before working for petitioner.      SMMT

has value to petitioner and to its Nyingma employees apart from

the spiritual value that Nyingma employees place on work.    SMMT

enabled the Nyingma employees to develop and expand their

practice of Dharma.   SMMT provided a benefit to the Nyingma

employees similar to an employer's offering to pay for college
                              - 28 -


courses taken by its employees.    Petitioner offered the

opportunity to practice SMMT in a structured environment, rather

than just learning about SMMT or skillful means in a classroom

setting.   Petitioner argues that respondent undervalued SMMT

because the materials provided under the license are more

extensive than a 4-week class.    We agree and adjust AVG's

valuation accordingly.

     AVG valued petitioner's right to market commercially SMMT as

supporting royalty payments of $1,000 per year.    Based on the

evidence in the record, petitioner did not earn any revenues from

marketing SMMT during the years in issue.    AVG determined that

petitioner could have reasonably expected to earn annual revenues

of about $20,000 when it entered the 1990 license amendment.      It

based this determination on a 5-day seminar that petitioner held

in 1995 that generated revenues of $7,500.    AVG determined that

royalty rates for the right to conduct seminars are generally 5

percent and applied this rate to the projected $20,000 annual

revenues for royalty payments of $1,000 in each of the years in

issue.

     Maitland believed that he could earn approximately $2,000 in

gross revenues from a 1-day seminar on SMMT.    There is no

evidence in the record that petitioner intended to market SMMT.

The fact that petitioner did not conduct any SMMT seminars during

the years in issue shows that this right lacked value.      In

addition, we find only a nominal distinction between SMMT and

skillful means.   Accordingly, the skillful means classes offered
                               - 29 -


by the Nyingma Institute diminish the value of petitioner's right

to market SMMT.    Petitioner's expert did not specifically value

petitioner's right to market SMMT.      As we have no other

appropriate basis to evaluate this licensed asset, we accept

Spiro's valuation of the SMMT marketing right.

     AVG also valued the computer software using the replacement

cost method and determined that the value of customized software

was $20,000, based on the cost of similar software, for an annual

value over a 5-year useful life of $4,000.      Maitland believed

that comparable off-the-shelf software would have cost between

$60,000 and $70,000.   However, petitioner did not consider

purchasing software from another company.      DM did not provide

technical support for the software.      This decreases the value of

the software because petitioner had to update the software

itself.   We believe that AVG's valuation of the software is more

reliable than Maitland's uncorroborated testimony and accept

AVG's valuation.

     Second, AVG relied on a market comparison to determine fair

market royalty payments for the licensed trade names and

trademarks.   For the comparison, AVG considered royalties paid

for instant-print or quick-print franchises.      It identified the

various assets received under these franchise agreements and

compared the quick-print franchises with the license agreement

only to the extent of the licensed trade names and trademarks.

Royalty rates associated with trade names and trademarks

represent the costs incurred by the franchisors to maintain the
                                - 30 -


value of the trade names and trademarks through advertising and

other promotional activities.    AVG determined that royalty rates

attributable to advertising range from 1 to 2.5 percent of the

franchisee's gross sales with an industry average of 2 percent.

AVG assigned a value to the licensed trade names and trademarks

of 1 percent of petitioner's gross sales, which produced royalty

payments in the amounts of $52,396, $57,636, and $62,823, during

the years in issue, respectively.    AVG established that DM did

not advertise the trade names or trademarks or engage in other

promotional activities.   DM has not registered the trade names or

trademarks with any governmental unit.    AVG believed that these

facts support a value for the licensed trade names and trademarks

that is substantially less than the average advertising fee rates

for quick-print franchises.   Petitioner contends that DM owns a

nonregistered, common-law trademark in the licensed trade names.

Petitioner asserts that the quick-print industry, used by AVG in

its valuation, is not comparable to petitioner's business.

Quick-print businesses rely on advertising to attract walk-in

customers, but lithographic printers, such as petitioner,

generally do not have walk-in customers.    Petitioner did not

advertise and relied on its quality and low prices to obtain

customers.

     Although DM has not engaged in commercial printing since

1985, petitioner agues that DM has developed name recognition for

the word "Dharma" in the printing industry through its religious

printing activity.   Petitioner's customers who testified at trial
                              - 31 -


did not attribute the name Dharma to DM's religious printing

business or state that they became petitioner's customers because

they associated the word Dharma with DM.   Petitioner attracted

customers by the quality of its printing and low prices.   There

is no evidence that petitioner's customers associated its quality

and prices with DM's business.   At most, its customers associated

its name with Buddhism in general and not to DM's printing

business.   DM has never used the names "Dharma Enterprises" or

"Skillful Means Press" in the printing business.   DM did use the

name "Amber Lotus" beginning in 1986.   Although there is no

evidence as to whether DM made Amber Lotus into a profitable

business before licensing it to petitioner, the name had some

value to petitioners.   During the years in issue, petitioner's

Amber Lotus division accounted for approximately 7 percent of

gross sales.   We hold that an unrelated third party would have

paid royalties for the trade names and trademarks in the amount

determined by AVG.

     In addition to being a recognized trade name in the printing

business, petitioner maintains that the Dharma name identifies it

as a Dharma-authorized organization and enables it to hire low-

wage employees.   The license agreement, as amended, purports to

grant to petitioner the right to present itself as an

organization sanctioned by an active Dharma lineage.    Petitioner

maintains that AVG's comparison of the Dharma name with quick-

print trade names does not account for this value.   We determine

that this alleged asset does not justify the royalty payments
                              - 32 -


disallowed by respondent.   Petitioner's other connections to

Buddhism and the Nyingma community also attracted low-wage

employees.

     Third, to calculate fair market royalty payments for DM's

customer list, AVG used an income approach to estimate the

revenues generated from the customer list during the years in

issue.   AVG estimated the number of customers from the list that

were active customers during the years in issue.    According to

AVG, revenues from a customer list decrease over time as customer

preferences and financial conditions change.    AVG determined a 9-

year useful life for DM's customer list beginning in 1985.    AVG

observed that over the 9-year life, a larger percentage of gross

sales from list customers was attributable to petitioner's own

efforts to maintain the customers.     Accordingly, it adjusted the

list's value for petitioner's costs to maintain the list.    AVG

also assumed that petitioner received the additions and changes

to DM's customer list after 1985 from petitioner's merger with

SMP and attributed new customers and increases in sales to a

particular customer after 1985 to either petitioner's or SMP's

efforts.   AVG valued the customer list, based on projected net

profits generated from the list, at $106,433, $86,098, and

$69,117, during the years in issue, respectively.

      Although its expert provided a value for the customer list,

respondent asserts that petitioner did not obtain a customer list

from DM under the license agreement.    The license agreement and

amendments did not mention the customer list.    Nevertheless, DM
                               - 33 -


transferred a customer list to petitioner, and the parties

intended the royalties to compensate DM for the list.     Respondent

further argues that petitioner received the customer list in its

merger with SMP.    Upon termination of SMP's license with DM, SMP

did not own the customer list; thus, it could not transfer it to

petitioner, as respondent argues.    Petitioner argues that DM also

received any new customers that SMP developed when the license

terminated.   We do not believe the uncorroborated testimony of

petitioner's witnesses that the customers developed by SMP also

reverted to DM.

     Petitioner's business records show that it retained a larger

number of customers than AVG predicted.     Over 50 percent of

petitioner's gross sales during the years in issue were

attributable to customers from DM's customer list.     Petitioner

argues that AVG did not consider the actual sales generated by

DM's customers when determining the value of the customer list.

We recognize this as a flaw in respondent's valuation of the

customer list, but there is no evidence in the record of the

revenues generated by the customers in 1985.     As AVG established,

it is necessary to adjust the value of the customer list for

petitioner's own efforts to maintain and increase the sales to

the customers.    SMP's 1987 gross sales of $2.8 million provide

some insight into the portion of sales revenues that is due to

petitioner's efforts.    Without specific information about the

revenues generated from the customers in 1985, our ability to

value the customer list is limited.     However, we find that
                               - 34 -


respondent undervalued the customer list, and we adjust our

decision accordingly.

     AVG determined that petitioner's ability to obtain financing

from DM had no value as part of the license agreement.    DM,

acting with other Nyingma organizations, provided financing to

petitioner at about 16-percent interest for the purchase of its

initial printing equipment and the four-color press in 1989.      AVG

determined that the prevailing interest rate in 1989 was about 10

percent.    AVG concluded that the license did not give petitioner

the right to below-market financing.    Therefore, AVG did not

assign any value to petitioner's purported right to financing.

     Petitioner argues that it would not have been able to start

its business without financing from DM and the Nyingma network

and community because petitioner's members did not make capital

investments in the business.    Petitioner paid interest on the

money borrowed from DM, and there is no evidence that the

interest rate was below the market interest rate.    We doubt that

DM provided financing as an independent third party or because of

the license agreement.   Rather, DM provided financing because of

its close relationship with petitioner and because DM intended to

receive the majority of petitioner's profits disguised as royalty

payments.   We hold that the financing from DM has no effect on

the royalty value.

     AVG also did not assign a value to DM's 5-year covenant not

to compete in commercial printing and DM's agreement to refer

customers to petitioner.    AVG reasoned that DM ceased commercial
                                - 35 -


printing in 1985 in order to maintain its tax-exempt status and

that DM did not intend to return to the commercial printing

business.   Without an intent to compete, AVG believed that the

covenant lacked economic meaning.    In addition, petitioner

indicated to AVG that customer referrals by DM were rare.

     Taxpayers may amortize the amount paid for a covenant not to

compete over its useful life.    Sec. 167(a); Warsaw Photographic

Associates, Inc. v. Commissioner, 84 T.C. 21, 48 (1985).       A

covenant not to compete must have "economic reality"; i.e., some

independent basis in fact or some arguable relationship with

business reality so that a reasonable person would bargain for

the agreement.   Patterson v. Commissioner, 810 F.2d 562, 571 (6th

Cir. 1987), affg. T.C. Memo. 1985-53; Beaver Bolt, Inc. v.

Commissioner, T.C. Memo. 1995-549.       The parties did not allocate

a portion of the royalties to the covenant.

     Courts apply numerous factors in evaluating a covenant not

to compete.   These include:   (a) The grantor's (i.e.,

covenanter's) business expertise in the industry; (b) the

grantor's intent to compete; (c) the grantor's economic

resources; (d) the potential damage to the grantee posed by the

grantor's competition; (e) the grantor's contacts and

relationships with customers, suppliers, and other business

contacts; (f) the grantee's interest in eliminating competition;

(g) the duration and geographic scope of the covenant; and (h)

the grantor's intention to remain in the same geographic area.

Warsaw Photographic Associates, Inc. v. Commissioner, supra.
                                - 36 -


      After considering the above factors, we find that the

covenant had economic reality and assign an appropriate value to

it.   DM had the ability and expertise to enter into the

commercial printing business.    DM stopped printing for commercial

customers in 1985 and sold printing equipment to petitioner.

However, DM continued to print and publish Tibetan Buddhist texts

and art.   DM's reputation as a Buddhist printer could easily

translate into a commercial printing business.   In addition, DM

had the necessary expertise, equipment, skilled personnel, and

contacts with suppliers to become a commercial printer.

Moreover, DM could adversely affect petitioner's business if DM

competed with petitioner.   On the other hand, performing

commercial printing would jeopardize DM's tax-exempt status and

distract from its Buddhist traditions.   We believe that DM may

have reentered the commercial printing business in the absence of

the payments from petitioner.

      We hold that royalty payments in the amounts of $265,000,

$250,000, and $240,000 for the years in issue, respectively, are

reasonable compensation for the licensed assets and DM's covenant

not to compete.

      Petitioner contends that the disallowed portion of the

royalty payments is deductible under section 162 as payments made

to a charitable organization in expectation of commensurate

financial benefit.   Sec. 1.170A-1(c)(5), Income Tax Regs.

However, petitioner did not have a reasonable expectation of

financial return in the amount of the payments because it paid
                               - 37 -


the substantial majority of its after-tax profits to DM.     There

is no evidence that petitioner received any economic benefits

from the payments to DM beyond the value of the licensed assets.

The excessive portion of the payments to DM is not deductible

under this argument.

     In the notice of deficiency, respondent did not allow

petitioner to deduct any portion of the disallowed payments to DM

as charitable contributions under section 170.    Petitioner did

not address on brief the deductibility of the excess payments to

DM as charitable contributions under section 170 and has not

proven that it is entitled to section 170 deductions.

Net Operating Loss Deduction

     Respondent disallowed NOL deductions in taxable years 1991

and 1993.   Petitioner generally has the burden of proof with

regard to NOL deductions.   Hill v. Commissioner, 95 T.C. 437,

439-444 (1990).   Petitioner contends, however, that respondent

has the burden to show that petitioner is not entitled to the NOL

carryforwards because respondent did not specify the disallowance

of the NOL’s in the statements or explanations attached to the

notice of deficiency.

     Respondent is not required to provide a factual basis for

disallowed deductions.   United States v. Zolla, 724 F.2d 808,

809-810 (9th Cir. 1984); Finkelman v. Commissioner, T.C. Memo.

1989-72, affd. 937 F.2d 612 (1991).     The notice must (1) advise

the taxpayer that respondent in fact has determined a deficiency,

and (2) specify the year and amount of the deficiency.     Campbell
                               - 38 -


v. Commissioner, 90 T.C. 110, 115 (1988).      Petitioner argues that

respondent must specify the year in which the NOL’s that produced

the disallowed carryover deduction arose and the reasons

respondent disallowed the NOL’s in that year.     We disagree.    The

notice of deficiency in this case identifies the years in which

the NOL deductions were disallowed and the amount of the

disallowed NOL deductions.    See sec. 7522.   This is a sufficient

explanation to apprise petitioner with regard to the NOL

deductions, and the burden of proof has not shifted to respondent

on that issue.

     Petitioner has failed to present sufficient evidence to

substantiate the claimed carryover losses that it deducted in

taxable years 1991 or 1993.    In addition, petitioner's expert

report does not address the value of the license in taxable years

1989 and 1990.   We sustain respondent's determination.

Adjustment to Gross Sales

     Respondent determined that petitioner's gross sales as shown

on its books and records are greater than its gross sales as

reported on its 1991 income tax return.    Petitioner reduced gross

sales reflected on its books for 1991 in the amount of $7,095 in

reporting gross sales to correct a customer overbilling.     It

introduced business records reflecting the overbilling, including

the invoices, a credit memorandum, and business journals.     In

addition, Maitland explained the nature of the discrepancy in the

amount of gross sales reported and shown on petitioner's books
                                - 39 -


and records.    We find that petitioner accurately reported its

1991 gross sales.

Section 6662 Penalty

     Section 6662(a) imposes a penalty of 20 percent of the

portion of an underpayment attributable to one or more of the

items set forth in section 6662(b), including negligence or

disregard of rules or regulations.       See sec. 6662(b)(1).

Negligence is defined as the lack of due care or failure to do

what a reasonable and ordinarily prudent person would do under

the circumstances.     Neely v. Commissioner, 85 T.C. 934, 947

(1985).   A section 6662 accuracy-related penalty does not apply

with respect to any portion of an underpayment if reasonable

cause exists for the underpayment and the taxpayer acted in good

faith with respect to such portion.       Sec. 6664(c)(1).   The

determination of whether a taxpayer acted with reasonable cause

and in good faith depends upon the pertinent facts and

circumstances of the case.    Sec. 1.6664-4(b)(1), Income Tax Regs.

Petitioner bears the burden of proving that the penalty does not

apply.    Rule 142(a); Luman v. Commissioner, 79 T.C. 846, 860-861

(1982).

     We find that petitioner paid royalties to DM significantly

in excess of the value of the licensed assets.       These payments,

which were a substantial portion of petitioner's profits, were

made to a closely related company.       The people in control of

petitioner and DM were similarly motivated to promote Buddhist

teachings.     Petitioner paid its profits to DM as royalties rather
                              - 40 -


than making contributions to Buddhist organizations in line with

its stated purpose to financially support the preservation of

Buddhism.   Petitioner has never made a charitable contribution to

support Buddhism.   Petitioner acted negligently and in disregard

of rules or regulations with regard to its deductions of the

royalty payments to DM.   Therefore, it is liable for a section

6662 penalty for each of the years in issue.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
