84 T.C. 412">*412 This case was submitted fully stipulated pursuant to Rule 122; ² the stipulation of facts and exhibits attached thereto are incorporated herein by this reference. However, many of the facts set forth herein are based upon our examination of the exhibits and were not set out in the stipulation.

84 T.C. 412">*413 Respondent determined the following Federal income tax deficiencies:

1985 U.S. Tax Ct. LEXIS 106">*107 The petitioners in this consolidated proceeding are among the 32 limited partners in a partnership known as 1975 Equipment Investors (Partnership), a limited partnership formed to acquire equipment for lease and/or sale. The pretrial order, dated May 26, 1983, severed for trial, in this proceeding solely 84 T.C. 412">*414 all tax issues arising out of the investment by petitioners in the Partnership. By stipulation, the parties submitted for our consideration only the following: (1) Whether the Partnership is the owner of various items of computer equipment for Federal income tax purposes; and (2) whether amounts paid by the Partnership to E.F. Hutton & Co., Inc. (E.F. Hutton), as an equity placement fee may be amortized over the life of the Partnership.

FINDINGS OF FACT

In Appendix A at the end of this opinion, we set forth the residences of the various petitioners in this proceeding when their petitions were filed and the number of Partnership units owned by them at all material times. Petitioners all were partners in the Partnership, which was formed by the well-known investment firm E.F. Hutton, a subsidiary of the E.F. Hutton Group, Inc. Prior to the activities at issue herein, E.F. Hutton had 1985 U.S. Tax Ct. LEXIS 106">*108 organized three other limited partnerships which had purchased IBM Systems 370 and 360 computer equipment for lease to a number of corporate lessees and had organized one limited partnership which had purchased a McDonnell Douglas DC-9 aircraft for lease to a commercial airline. E.F. Hutton also had participated as a broker in bringing together prospective lessors and lessees of computer equipment.

On January 15, 1975, E.F. Hutton formed 1975 Equipment Manager, Inc. (Equipment Manager or the general partner), a Delaware corporation, the sole function of which was to act as general partner of the Partnership. During all material times, Equipment Manager was a wholly owned subsidiary of E.F. Hutton.

The Partnership, a New York limited partnership, also was formed on January 15, 1975, pursuant to article 8 of the New York Partnership Law. As set forth in the amended and restated articles of limited partnership (Partnership agreement), the Partnership was to acquire computer central processing units and related equipment (collectively referred to as equipment), to lease or sell the equipment to others and 84 T.C. 412">*415 to perform any acts to accomplish those purposes. ^{31985 U.S. Tax Ct. LEXIS 106">*110} 1985 U.S. Tax Ct. LEXIS 106">*109 The Partnership agreement provided for a general partner, one class B limited partner, ⁴ and for the issuance of up to 52 class A limited partnership units. The general partner was to receive a commencement fee of $ 25,000 in consideration for its services, in addition to a management fee of 2.1 percent of Partnership gross income. ⁵ The overhead of the general partner was not considered to be an expense of the Partnership. Under the terms of the Partnership agreement, all items of income or loss were to be allocated, and all distributions of cash made, in accordance with each partner's pro rata share. All net cash-flow of the Partnership was to be distributed, first to the general partner to the extent of outstanding advances (plus interest), and thereafter to all partners in accordance with their pro rata shares at the time of distribution. The Partnership life was to commence on the day on which its certificate was filed and to end no later than December 31, 1983.

In July and August 1975, the Partnership prepared a private placement memorandum (memorandum) to be used for offering limited Partnership interests to selected E.F. Hutton customers. 1985 U.S. Tax Ct. LEXIS 106">*111 As described in the memorandum, the instant transaction was to be structured as follows: Upon receipt of sufficient capital from prospective investors, the Partnership was to purchase IBM System 370 computers for approximately $ 9 million by borrowing a substantial portion of the cost of each computer, and immediately thereafter it was to lease the 84 T.C. 412">*416 computers to financially sound lessees for a period of time sufficient to repay fully the borrowings. In order to borrow funds at commercially reasonable interest rates, the Partnership was to pledge both the equipment and the leases as security to the lenders. The memorandum indicated that the Partnership tentatively had arranged to purchase three IBM System 370 computers and lease them to three separate lessees: Sterling Drug Co. (Sterling), Borg-Warner Corp. (Borg-Warner), and Exxon Corp. (Exxon). All of these purchases and leases were arranged through the efforts of equipment brokers, who specialized in IBM computer equipment. The parties have stipulated that, at the time the memorandum was prepared, the Partnership anticipated purchasing and leasing a fourth IBM 370 System, depending on the degree of success of the offering, and 1985 U.S. Tax Ct. LEXIS 106">*112 the memorandum so indicated. According to the memorandum, during the terms of the initial leases, the Partnership was expected to realize sufficient cash-flow to cover Partnership expenses and to permit modest cash distributions to the limited partners beginning in 1976. It further indicated that, upon expiration of the initial lease terms, the Partnership planned either to re-lease or sell the computers on a basis which would result in the largest possible gain to the Partnership.

Concerning the economic feasibility of investing in the Partnership, each investor was advised in the memorandum to consult his own counsel as to the legal and economic risks and benefits of the investment. It indicated that the investment objectives of the Partnership were:

To provide an investment opportunity, including

(a) Maximum use of tax benefits applicable to the Partnership's business, and

(b) Modest cash distributions to the Limited Partners beginning in 1976, and

(c) Realization of net cash proceeds upon sale or re-leasing of the computer equipment at the end of the initial leases.

On its face, the memorandum made it clear that investment in the Partnership was only for certain types of investors 1985 U.S. Tax Ct. LEXIS 106">*113 -- those who were able to commit capital for a long-term investment of limited liquidity, who were able to bear the risk of losing their investment, and who were in a position to benefit from the expected tax benefits of the Partnership. Numerous references 84 T.C. 412">*417 are made in the memorandum to taxpayers in the 50-, 60-, and 70-percent brackets, and to the general tax consequences to them of investment in the Partnership. With regard to tax benefits, however, the memorandum cautioned:

Although the tax benefits anticipated from the Partnership could be said to have the effect of providing a return on investment in the earlier years, tax obligations will arise in later years; the ultimate success of the Partnership will therefor depend upon the profitability of its business and the residual value of the equipment in the later years.

In attempting to provide prospective investors with an assessment of the importance of residual value potential, the memorandum explained that, "on termination of the leases at the end of a projected term of 8 years, unless the computers have a residual value of approximately 14% of the Partnership's original purchase price, the Partnership will suffer an economic 1985 U.S. Tax Ct. LEXIS 106">*114 loss on the computers." The memorandum declined to predict the expected residual value of the computers, cautiously describing the computer leasing industry as very competitive and emphasizing that price changes and technological obsolescence could have a materially adverse effect upon the Partnership's ability to re-lease or sell the equipment at the end of the lease terms. By the same token, it indicated that risks were minimized, because the models were purchased early in their life cycles.

The following schedule copied from the memorandum contains a calculation of the expected cash-flow to the Partnership based upon the projection of total rental income extrapolated from the three tentatively negotiated leases and the expected expenses:

1985 U.S. Tax Ct. LEXIS 106">*115 84 T.C. 412">*418 Contrary to the projections, the actual cash distributions were zero for all years except 1976, when a cash-flow of $ 8,897.88 was achieved and $ 220 per unit distributed.

The net economic effects of an investment in one Partnership unit (assuming that 40 units would be sold and the anticipated leases ran their full terms), without considering the residual value of the equipment at the end of the leases but taking into account tax benefits, were estimated in the memorandum for taxpayers in the 50-, 60-, and 70-percent tax brackets as follows:

The memorandum then proceeded to quantify the results of the purchase of one $ 30,000 investment unit, based 1985 U.S. Tax Ct. LEXIS 106">*116 upon realization of various potential residual values of the equipment which, when added to the net tax benefits and cash-flow indicated above, resulted in the following proceeds: 84 T.C. 412">*419

In presenting these residual value figures, however, the memorandum again cautioned:

There is not sufficient experience to accurately estimate the residual value of System/370 equipment. Technological obsolescence and the effects 84 T.C. 412">*420 of inflation are two major variables which make residual evaluation difficult. * * *

The Partnership retained E.F. Hutton to act as its agent in soliciting offers to subscribe to 40 ⁷ class A limited partnership units at $ 30,000 per unit. Other than the memorandum, E.F. Hutton furnished no sales literature or other written information to prospective limited partners. Through its national brokerage network, E.F. Hutton, acting as the Partnership's exclusive sales agent, successfully raised the full amount of capital 1985 U.S. Tax Ct. LEXIS 106">*118 ($ 1,200,500) by selling 40 class A limited partner units to 32 investors. Each type of partner's contribution to, and pro rata share of, the Partnership was as follows:

This $ 1,200,500 in cash was disbursed in 1975 as follows:

The "equity placement fee" referred to above was paid by the Partnership in September 1975. This fee was a sales commission of 8 1/2 percent of the capital raised, which represents a fair and reasonable fee for an offering of this type.

After the offering was completed, the Partnership, through a broker, identified a fourth leasing opportunity with Nissan Motor Corp. (Nissan), and a lease between Nissan and the Partnership was negotiated in November 1975. The projected 84 T.C. 412">*421 cash-flow on the basis of the four leases is contained in Appendix B at the end of this opinion. The predicted income and expenses of the Partnership during the terms of the four leases (excluding residual value) did not vary significantly from those which had been predicted in the memorandum, ¹⁰ and neither prediction anticipated a substantial positive net cash-flow during the lease terms.

The directors and executive officers of the general partner from its formation through 1978 were all executives of E.F. Hutton and were compensated by E.F. Hutton. E.F. Hutton established a separate office and staff ^{111985 U.S. Tax Ct. LEXIS 106">*121} in Rochester, New York, to perform the duties of the general 1985 U.S. Tax Ct. LEXIS 106">*120 partner, including negotiation and administration of the leases with Sterling, Borg-Warner, Exxon, and Nissan. The staff also maintained records reflecting the monthly payment of rent by the various lessees, and the application of these payments to debt service and to the payment of Partnership expenses. These records were reviewed quarterly in connection with the preparation of unaudited quarterly financial statements which were supplied to all limited partners. Audited financial statements were prepared annually and certified by the public accounting firm of Arthur Andersen & Co. The Partnership reported its ownership of the computer equipment to various State and local authorities. The performance of the lessees under the various leases was monitored to assure that the equipment had been properly identified by tags or other means disclosing the Partnership as owner, and that the lessees' required insurance coverage showing the Partnership as an insured was maintained or self-insurance was properly elected.

Leasing and Financing Arrangements

The four lessees each placed orders directly with IBM for the systems they desired and then transferred these orders to the respective brokers or to the Partnership. The Partnership had no role in selecting the equipment packages ordered by the lessees, nor in advising the lessees as to which equipment 84 T.C. 412">*422 would be appropriate for their needs. Upon delivery, title was conveyed in three cases from IBM to the brokers and by the brokers to the Partnership; in the fourth case (Nissan), IBM conveyed title directly to the Partnership. The Partnership acquired legal title to each of the systems before the equipment was placed in service by the lessees. The Partnership paid the following amounts to brokers in connection with the lease arrangements:

All dealings between the Partnership and the brokers were at arm's length, and broker fees were stipulated to be reasonable in amount.

In 1985 U.S. Tax Ct. LEXIS 106">*123 accordance with customary industry practices, payment to IBM was made by the Partnership within approximately 30 days after it acquired legal title to the equipment. The Partnership paid fair market value for the equipment. The total purchase price paid by the partnership to IBM for the four computer systems was $ 9,070,234, paid for by $ 945,673 of Partnership cash and $ 8,124,561 of nonrecourse debt, which was secured by the equipment and an assignment of the leases. The financing of the various models of computers at issue here was as follows: 84 T.C. 412">*423

The amount of the monthly rental payments to the Partnership under all leases was consistent with rentals for comparable long-term equipment leases. The parties have stipulated that the amount of these rental payments was negotiated at arm's length, and that for each lease, the rental payments were less than those available under third-party operating leases ^{161985 U.S. Tax Ct. LEXIS 106">*125} or under leases made directly with IBM. However, the amount also was negotiated with some reference to the cost of equipment and the cost of money required to purchase such equipment. The monthly lease payments to the Partnership and the amounts due monthly from the Partnership to the lenders were as follows: 84 T.C. 412">*424

Rentals were to be paid directly to the financing bank, and the banks were directed to apply the rentals to repayment of amounts due from the Partnership, to remit to Alanthus its brokerage fees (in the case of Exxon), and in all four cases, to pay the excess to the Partnership. All four leases were "net leases" in a form commonly used in the industry. The lessees were responsible for all fees and taxes incurred in connection with the equipment (excluding income taxes payable by the lessor), and were required to keep the equipment insured at their expense. The lessees also were required to maintain the equipment at their expense and to keep in force an IBM maintenance agreement (or, in the case of Exxon, an equivalent maintenance agreement) with respect to the equipment. Two of the leases expressly state that title to the equipment at all times remained with the lessor, and it is stipulated that the lessees had no rights to interests in the equipment except as lessees under the four leases in the record.

The lessor was not responsible to the lessees for the consequences 1985 U.S. Tax Ct. LEXIS 106">*126 of defects in, damage to, or loss or destruction of the equipment. In the event of repairable damage to the equipment, the lessees were required to repair it at their own expense. In the event of damage beyond repair, the lessees were required in one case, to replace the equipment, in two of the others, to pay the lessor a casualty loss value (which was specified in schedules to the leases as a percentage of equipment cost, such percentage declining slightly each month), and in the fourth case, to pay the greater of the casualty loss value (which was specified as a lump-sum dollar value that declined each month) or the full replacement cost.

All four of the lessees had options to terminate their leases prior to expiration of the initial lease periods, subject to payment of stated termination payments also set forth in schedules attached to the leases. One of these schedules recited specific lump-sum dollar values, and the others expressed the 84 T.C. 412">*425 termination values as a percentage of original cost. Termination was only permitted after the passage of 5 months in the case of the Exxon lease, 39 months in the cases of the Sterling and Borg-Warner leases, and 52 months in the case of the 1985 U.S. Tax Ct. LEXIS 106">*127 Nissan lease. Termination payments and casualty payments were, on all dates set forth in the schedules, more than sufficient to pay off all Partnership debts with respect to the computers subject to the leases. In two cases, in the event that a lessee decided to terminate, the lessor and lessee were to use their best efforts to sell (and in one case to sell or re-lease) the equipment subject to the terminated lease, and the lessee was only required to pay the amount, if any, by which the termination value exceeded the highest offer. If no offer was made, the terminating lessee had to pay the full termination penalty, ¹⁷ whereupon the lease obligations would cease, and the lessor was free thereafter either to re-lease or sell the equipment. In the two other cases, the lessor was required to sell the equipment for the highest cash offer and refund the proceeds (less the selling expenses) to the terminating lessee.

In three of the leases, the lessees had options to purchase or re-lease the equipment under the leases at the end of the initial lease terms. Such options required the payment 1985 U.S. Tax Ct. LEXIS 106">*128 of fair market value or fair market rent, as of that date, to the Partnership. No lease contained a provision obligating the lessee to purchase or re-lease the equipment at the end of the respective lease term. In the absence of such renewal or purchase, upon expiration of each lease, the lessees were obligated, at lessees' expense, to deliver the equipment to a location to be specified by the Partnership. The leases were scheduled to terminate on the following dates:

As required by the lease terms, the Partnership filed appropriate elections, and the lessees claimed all available tax credits in connection with the equipment.

84 T.C. 412">*426 Pursuant to the terms of its lease, Exxon, one of the lessees, had the right to request the lessor to purchase and lease to Exxon any IBM model upgrades or features for its system, provided appropriate terms could be negotiated. By reason of that lease provision, in late 1976 and mid-1977, two sets of upgrade equipment were leased to Exxon.

In August 1978, because of IBM price reductions, Exxon decided to terminate its lease unless rental payments were reduced. In the event of early 1985 U.S. Tax Ct. LEXIS 106">*129 termination, the Partnership would have received rental income in a substantial lump sum from the termination payments. In the event that such termination resulted in the sale of the equipment, substantial recapture of depreciation would have occurred. In order to avoid these adverse tax consequences, a restructured lease was entered into in September of that year which extended the old lease term until September 15, 1985, and reduced Exxon's monthly rental on both the original equipment and the two upgrades from $ 73,476 to $ 60,000. Under the restructure, Alanthus was not entitled to any brokerage fees and assumed the full economic risks of termination payments. In connection with the renegotiation of the Exxon leases, the Partnership restructured its debt by borrowing $ 3,335,571.91 from a bank and paying off the earlier loans obtained in connection with the equipment leased to Exxon. The monthly payments on the new debt were equivalent to Exxon's new rental payment to the Partnership.

During this period of time, the obsolescence of computer equipment occurred primarily as a result of technological advances. Thus, for purposes of this case, the rate of obsolescence 1985 U.S. Tax Ct. LEXIS 106">*130 or diminishing value is directly related to the rate of introduction of new, technically advanced equipment models. During these years, IBM was the primary factor influencing the prices for used IBM computer equipment. IBM announcements about new products or price changes usually had an immediate impact on the market values of used IBM computers.

In the early 1960's, IBM had a major impact on the computer world with the announcement of the IBM 360 family of computers. This product line was a drastic departure from 84 T.C. 412">*427 previous offerings in that it combined into a single family unit what had been previously a conglomeration of several different models. For a long time thereafter, it appeared that IBM's pace of new products and pricing policies were stable and relatively predictable. IBM tended to announce major generations of new computers at intervals of 5 to 6 years.

In 1971, IBM introduced the first models of the System 370, which provided increased internal processing speed and data storage capacity, resulting in a lower cost per unit of work processed as compared to the System 360. The IBM System 370 Model 168, which was leased to Exxon, was announced in 1972 as the successor to 1985 U.S. Tax Ct. LEXIS 106">*131 an earlier model of the System 370. A high-end virtual storage machine, it provided cost savings and operational advantages over its predecessor and became quite popular with very large advanced users. The IBM Model 3158, leased to Nissan, also was one of the larger members of the 370 series. It was announced in 1972 and was a successor to the System 370 Model 155, ¹⁸ becoming available in April 1973. IBM Model 3145 units were leased to Sterling and Borg-Warner. That model was a medium sized, general purpose computer with advanced memory capabilities. This advanced version was announced in February 1973.

During the early 1970's, internal IBM documents had indicated a plan for a "Future System" (FS). It was generally known in the industry that the FS was expected to be another dramatic departure from earlier IBM trends, similar in scope to the differences between the Model 360 and earlier families. However, by May 1975 many in the field believed that IBM 1985 U.S. Tax Ct. LEXIS 106">*132 was going to cancel the FS program, and this knowledge had a buoying effect on the residual value predictions of many experts at the time. ^{191985 U.S. Tax Ct. LEXIS 106">*133} By October 1976, it was clear that IBM had abandoned the FS and that future changes in IBM's product lines would be "evolutionary" rather than "revolutionary." 84 T.C. 412">*428 As it actually turned out, however, IBM in January 1979 announced a completely new line of computers, the IBM Model 4300, which had a profound effect on the computer industry and rendered obsolete prior predictions concerning residual values of used IBM 370 models. ²⁰

Those E.F. Hutton executives who were concerned with the instant transactions were familiar with computer equipment, and with equipment leasing transactions and residual value projections in connection therewith. ²¹ From their familiarity with those projections, they expected in 1975 a minimum residual value range for the instant equipment of 15 to 20 percent and believed that expectations of as high as 30 percent were reasonable. ^{221985 U.S. Tax Ct. LEXIS 106">*134}

We find these estimates to be thoroughly reliable, reasonable, and confirmed by the evidence in the record as a whole. ^{231985 U.S. Tax Ct. LEXIS 106">*136 1985 U.S. Tax Ct. LEXIS 106">*137} 84 T.C. 412">*429 The parties have stipulated that, as of August 1975, it was reasonable to expect the equipment to have remaining useful lives of at least 3 years at the end of the initial leases, and 1985 U.S. Tax Ct. LEXIS 106">*135 that it also was reasonable to expect that the aggregate residual value of all equipment owned by the Partnership at the end of the lease terms would be at least 14 percent of the overall expected cost of that equipment. A 14-percent residual value based upon an original cost of approximately $ 9 million (indicated in the memorandum to be the equipment's total expected cost) would have generated approximately $ 1,260,000. ²⁴ When this amount is added to the total cash-flow predicted in the memorandum during the terms of the leases of approximately $ 70,000, a 14-percent residual value would have produced something very close to a breakeven for the Partnership after 5 percent in broker's fees for selling the equipment ²⁵ is taken out. ²⁶ A 20-percent residual value would have produced a pre-tax profit to the Partnership of $ 580,000. ²⁷

The fact that some 4 years later the bottom fell out of the used computer market does not alter the reasonable nature of the predictions in August 1975. The higher predictions were made in part in reliance upon continued high anticipated levels of inflation ²⁸ and IBM's historically slow and steady advancement in the field. Rumors that the Future System would be abandoned encouraged many to believe that, since models likely to be introduced by IBM in the future might be compatible with the 370 models, the residual values of those models would 1985 U.S. Tax Ct. LEXIS 106">*138 be substantial. Moreover, in January 1975, IBM announced an 8-percent increase in the price of new 370 computers. Residual values were generally expressed as a 84 T.C. 412">*430 percentage of the current IBM list price at the time of the residual value prediction; therefore, expected increases in list prices understandably would result in even higher expected residual values when expressed as percentages of original costs. ^{291985 U.S. Tax Ct. LEXIS 106">*139} Accordingly, in view of the fact that the Partnership was expected to break even if a 14-percent residual value were achieved and that contemporaneous predictions indicated that a 20- to 30-percent residual value was reasonably possible, there was a reasonable expectation of profit accruing to the Partnership by the end of the lease terms. Thus the Partnership entered into the activity with the requisite profit objective.

The Partnership reported its income and expenses on a cash basis. Income consisted primarily of gross rental receipts received under the leases. Expenses included depreciation, management fees, amortization of brokerage fees and deferred costs, State sales tax, interest, and miscellaneous administrative expenses. The equity placement fee paid to E.F. Hutton -- which is in issue -- was amortized over a 9-year period. On its Federal income tax returns (Forms 1065) for 1975 through 1982, the Partnership reported the following:

The income or loss per class A limited Partnership unit resulting from those amounts was as follows:

84 T.C. 412">*431 Petitioners reported their shares of these amounts on their returns for some or all of the years 1976, 1977, 1978, ^{311985 U.S. Tax Ct. LEXIS 106">*141} and respondent disallowed petitioners' shares of Partnership losses and investment interest expense deductions ³² stating, inter alia, either that it had not been established (1) that a deductible loss had been sustained by the Partnership or (2) that the petitioners or the Partnership was the owner of the subject equipment because they had not incurred the benefits and burdens of ownership and thus the leases were not true leases. If the Partnership is determined to be the true owner of the equipment, respondent asserts that amounts paid for the equity placement fee to E.F. Hutton constitute a capital asset that may not be amortized.

OPINION

The first question to be addressed is whether the Partnership is correctly viewed as the owner of the equipment for tax purposes. Petitioners take the position that the Partnership is the owner because it bore the benefits and burdens of ownership. While there was expected to be little positive net cash-flow to the Partnership during the lease periods, and little risk that lease payments would not fully amortize the debt in connection with the equipment, petitioners contend the Partnership 84 T.C. 412">*432 at all times retained legal title and the right to the equipment's residual value at the end of the lease terms. Thus, it is argued, the Partnership bore the risk that its initial cash outlay of $ 1.2 million could be lost entirely, and it also possessed a reasonable opportunity for profit, in that the residual value 1985 U.S. Tax Ct. LEXIS 106">*142 could be substantially in excess of the cash investment.

Respondent's position is that the instant equipment leasing transaction is merely a tax-avoidance scheme, and that the Partnership's ownership of the equipment should be disregarded for tax purposes. In support of this position, respondent urges three legal tests: (1) The leasing arrangements do not satisfy the tests of substance established by the Supreme Court in Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561 (1978); (2) the Partnership did not acquire the benefits and burdens of owning the equipment; and (3) the Partnership did not assume the substantive risk of loss of value. Respondent's conclusion therefrom is that the true characterization of these transactions is either a financing arrangement or a sale of the equipment by the Partnership to the lessees. Respondent focuses principally upon the contention that the instant transaction was intended merely to break even, so that petitioners were merely purchasing tax writeoffs. We view respondent's three arguments as essentially interconnected. Fundamentally, respondent contends that the Partnership's ownership of the equipment was so devoid of economic substance that it 1985 U.S. Tax Ct. LEXIS 106">*143 should be disregarded.

In ascertaining the proper characterization of the Partnership's interest, the parties' characterization of the form of the transaction should be respected so long as the lessor retains significant and genuine attributes of a traditional lessor. 435 U.S. 561">Frank Lyon Co. v. United States, supra at 585. The existence of tax benefits accruing to its investors does not necessarily deprive a transaction of economic substance. 435 U.S. 561">Frank Lyon Co. v. United States, supra at 574, 581; Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, 380 U.S. 563">579-580 (1965) (Harlan, J., concurring); Rice's Toyota World, Inc. v. Commissioner, 81 T.C. 184">81 T.C. 184, 81 T.C. 184">196 (1983), affd. on this issue 752 F.2d 89">752 F.2d 89 (4th Cir. 1985); McLane v. Commissioner, 46 T.C. 140">46 T.C. 140, 46 T.C. 140">145 (1966), affd. per curiam 377 F.2d 557">377 F.2d 557 (9th Cir. 1967), cert. denied 389 U.S. 1038">389 U.S. 1038 (1968). But where the transactions were entered into without any economic purpose 84 T.C. 412">*433 other than favorable tax consequences, the courts have appropriately disregarded the form. E.g., Knetsch v. United States, 364 U.S. 361">364 U.S. 361 (1960); Higgins v. Smith, 308 U.S. 473">308 U.S. 473 (1940); Gregory v. Helvering, 293 U.S. 465">293 U.S. 465 (1935); Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221 (1981); Derr v. Commissioner, 77 T.C. 708">77 T.C. 708 (1981); 1985 U.S. Tax Ct. LEXIS 106">*144 Hager v. Commissioner, 76 T.C. 759">76 T.C. 759 (1981); Narver v. Commissioner, 75 T.C. 53">75 T.C. 53 (1980), affd. per curiam 670 F.2d 855">670 F.2d 855 (9th Cir. 1982); Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1534 (1980), affd. 678 F.2d 818">678 F.2d 818 (9th Cir. 1982); Estate of Franklin v. Commissioner, 64 T.C. 752">64 T.C. 752 (1975), affd. 544 F.2d 1045">544 F.2d 1045 (9th Cir. 1976).

Respondent's position that the instant transaction in reality was a sale is necessarily predicated upon the theory that the equipment would be effectively "used up" so that there would be nothing to be returned by the lessees to the Partnership at the end of the lease terms. This perception is, however, belied by the stipulation and the evidence before us. The parties have stipulated that the computers were expected to have a useful life of at least 3 years beyond the lease terms and that a residual value of at least 14 percent was reasonably expected, which amount would have enabled the Partnership to recoup its original cash investment and to break even. The record as a whole, moreover, supports a reasonable potential for considerably higher residual values -- as much as 30 percent. ³³ Thus, as we have found, the Partnership engaged in the activity with the objective of making 1985 U.S. Tax Ct. LEXIS 106">*145 a profit. ³⁴

Moreover, there is no dispute that the Partnership at all times retained its rights as owner of the equipment. While the Partnership did contract away a number of risks with respect to the equipment, net leases are commonly used today and do not necessarily reflect an absence of ownership. See Hilton v. Commissioner, 74 T.C. 305">74 T.C. 305, 74 T.C. 305">348 (1980), affd. per curiam 1985 U.S. Tax Ct. LEXIS 106">*146 671 F.2d 316">671 F.2d 316 (9th Cir. 1982), cert. denied 459 U.S. 907">459 U.S. 907 (1982); LTV Corp. v. Commissioner, 63 T.C. 39">63 T.C. 39, 63 T.C. 39">49-50 (1974). Similarly, the 84 T.C. 412">*434 absence of significant positive net cash-flow during the lease terms is a neutral factor. See 74 T.C. 305">Hilton v. Commissioner, supra.On the other hand, the Partnership did retain a significant benefit and burden with respect to the equipment -- that residual value would either generate a profit or a loss. ³⁵

Consequently, there is no basis for concluding that the lessees acquired an equity in the instant equipment. ³⁶The lease terms were substantially shorter than the equipment's useful lives, as the parties have stipulated, which is characteristic of a lease. See, e.g., Bowen v. Commissioner, 12 T.C. 446">12 T.C. 446, 12 T.C. 446">459 (1949); Holeproof Hosiery Co. v. Commissioner, 11 B.T.A. 547">11 B.T.A. 547, 11 B.T.A. 547">556 (1928). ³⁷ Reasonable rental payments, such as those here, also are indicative 1985 U.S. Tax Ct. LEXIS 106">*147 of a bona fide lease in that they are not likely to be payments by the lessee for purchase of equity in the property. See Frank Lyon Co. v. United States, 435 U.S. 582">435 U.S. 582 (1978); Oesterreich v. Commissioner, 226 F.2d 798">226 F.2d 798, 226 F.2d 798">803 (9th Cir. 1955), revg. a Memorandum Opinion of this Court; Belz Investment Co. v. Commissioner, 72 T.C. 1209">72 T.C. 1209 (1979), affd. 661 F.2d 76">661 F.2d 76 (6th Cir. 1981); Haggard v. Commissioner, 24 T.C. 1124">24 T.C. 1124, 24 T.C. 1124">1128 (1955), affd. per curiam 241 F.2d 288">241 F.2d 288 (9th Cir. 1956). The parties' treatment of the leases as such on their books and records -- including treatment of lease payments by at least some of the lessees as deductible business expenses -- is an additional factor indicating a bona fide lease. See Benton v. Commissioner, 197 F.2d 745">197 F.2d 745, 197 F.2d 745">753 (5th Cir. 1952).

Upon conclusion of the leases, the equipment was to be physically returned to (or as directed by) the Partnership. In 1985 U.S. Tax Ct. LEXIS 106">*148 the three instances where the lessees had options to purchase or re-lease, the lessees were required to pay fair market value or rental. Cases which hold that equity is being transferred to a lessee in instances where exercise of an option to purchase is inevitable because the option price is nominal or small are simply not in point here. See American Realty Trust v. United States, 498 F.2d 1194">498 F.2d 1194, 498 F.2d 1194">1199 (4th Cir. 1974); 226 F.2d 798">Oesterreich v. 84 T.C. 412">*435 ;72 T.C. 1209">Belz Investment Co. v. Commissioner, supra.³⁸ See also Smith v. Commissioner, 51 T.C. 429">51 T.C. 429, 51 T.C. 429">439 (1968) (exercise of option compelled by agreement with third party). In 63 T.C. 39">LTV Corp. v. Commissioner, supra, we rejected respondent's argument that the existence of an option to purchase indicated a conditional sale, because the option price was "comparable with the computer's estimated fair market value at the end of the lease term." 63 T.C. 39">63 T.C. 50. ^{391985 U.S. Tax Ct. LEXIS 106">*149}

The facts here are distinguishable from those in Swift Dodge v. Commissioner, 76 T.C. 547">76 T.C. 547 (1981), revd. 692 F.2d 651">692 F.2d 651 (9th Cir. 1982), where our holding that the lease agreements before us were not in fact conditional sales contracts was reversed by the Court of Appeals. While in some respects the obligations and rights of the lessee, there, resemble those of the lessees, here, the crucial distinction -- and an important ground for the Court of Appeals' reversal of our decision -- was that the Swift Dodge leases were "open-ended": The lessee at lease end was required to pay the lessor the amount, if any, by which the "depreciated value" (set forth in the lease) exceeded its actual value; in the event that the actual value exceeded the depreciated value, the lessee received the difference. Thus, the Court of Appeals concluded, the lessee assumed the risk of depreciation, and the arrangement in reality was a conditional sale. 692 F.2d 651">692 F.2d at 654. In contrast, the leases here were closed-ended in that the Partnership bore the risk at the end of the leases that the residual value would not be sufficient to recoup its cash outlay. At the same time, the Partnership possessed the 1985 U.S. Tax Ct. LEXIS 106">*150 potential for gain if residual values exceeded its investment. See Swift Dodge v. Commissioner, 76 T.C. 547">76 T.C. 568-569 n. 11. ⁴⁰ For similar reasons, our decision in Leslie Leasing Co. v. Commissioner, 80 T.C. 411">80 T.C. 411 (1983), likewise is distinguishable.

84 T.C. 412">*436 Nor are we persuaded by respondent's contention that the fact that the Partnership's debt obligations would be extinguished at lease end shows that a sale was intended. This Court has upheld lease transactions where total rentals over the lease terms equaled or even exceeded the total cost of the equipment. 1985 U.S. Tax Ct. LEXIS 106">*151 E.g., Kansas City Southern Railway Co. v. Commissioner, 76 T.C. 1067, 1102-1103 (1981). Rent during an initial lease term geared to the cost of interest and mortgage amortization is not, in and of itself, much more than a neutral commercial reality. Dunlap v. Commissioner, 74 T.C. 1377">74 T.C. 1377, 74 T.C. 1377">1436 (1980), revd. on another issue 670 F.2d 785">670 F.2d 785 (8th Cir. 1982); Hilton v. Commissioner, 74 T.C. 305">74 T.C. 305, 74 T.C. 305">348 (1980), affd. per curiam 671 F.2d 316">671 F.2d 316 (9th Cir. 1982), cert. denied 459 U.S. 907">459 U.S. 907 (1982).

With regard to respondent's "financing arrangement" theory, we see little to distinguish this case from 435 U.S. 561">Frank Lyon Co. v. United States, supra, where the Supreme Court upheld the form of a transaction structured very similarly to the one before us but in some respects not as strongly indicative of a lease transaction. For example, in this case the lessor's initial equity ($ 1.2 million) represented approximately 13 percent of the equipment's total cost ($ 9,070,234), whereas in Frank Lyon, it represented about 6 percent. The potential lease term in Frank Lyon aggregated 65 years, which probably was close to the useful life of the building; here, the lease terms were only 8 years, and the computers were 1985 U.S. Tax Ct. LEXIS 106">*152 expected to have useful lives of at least 3 years beyond lease termination. In Frank Lyon, the renewal rental was fixed at approximately one-half of the initial term, whereas, here, renewal rental was at fair market rent. Consequently, even more than in Frank Lyon, the Partnership, here, retained "significant and genuine attributes of the traditional lessor status." 435 U.S. 582">435 U.S. at 585.

In addition, the tests of substance set forth in Frank Lyon are met here. Respondent argues that the fact that the notes are nonrecourse evidences a lack of true substance, but, contrary to respondent's contentions, we have stated repeatedly that we do not believe that the nonrecourse nature of notes is necessarily more than a "neutral factor," since nonrecourse liabilities are commonly used in modern transactions. ^{411985 U.S. Tax Ct. LEXIS 106">*153} See 84 T.C. 412">*437 74 T.C. 1377">Dunlap v. Commissioner, supra at 1435; 74 T.C. 305">Hilton v. Commissioner, supra at 363.

The "business reality" presented to the Partnership was a potential for profit upon realization of residual value at the end of the lease term. ^{421985 U.S. Tax Ct. LEXIS 106">*154} The business purpose to the lessees, ⁴³ at least in part, appears to involve the fact that the rent paid to the Partnership was less than that which would have been paid to IBM if the equipment had been rented directly from IBM. Moreover, as respondent concedes, the lessees were spared the capital investment, which is true with any lease. While respondent contends that the lessees could have purchased the equipment themselves, either outright or by means of debt financing, this sort of speculation is not appropriate to our analysis. As the Supreme Court said in Frank Lyon, "a transaction must be given its effect in accord with what actually occurred and not in accord with what might have occurred." 435 U.S. 561">435 U.S. at 577.

But most importantly, the two interrelated remaining factors enunciated by the Frank Lyon Court -- that the transaction contain "economic substance" and be "imbued with tax-independent considerations" -- have been met here. As we have already discussed, there was a reasonable potential for profit which clearly constitutes the requisite substance. Unlike respondent, we find the emphasis in the private placement memorandum upon tax benefits expected from investment in the Partnership to be reasonable and normal under the circumstances. As we have noted, the existence of tax benefits does not necessarily deprive a transaction of economic substance. Moreover, the absence of any concrete assurances of profit to the investors does not indicate to us that no profit was intended. Rather, this reflects the conservative requirements of securities laws. Similarly, the Exxon restructure -- whereby the Partnership avoided the depreciation recapture 1985 U.S. Tax Ct. LEXIS 106">*155 and income realization that would have occurred in the event of 84 T.C. 412">*438 termination by Exxon and sale of the equipment by the Partnership -- indicates to us not that tax consequences were the sole motivating force but that they quite appropriately were one factor considered at that stage of the transaction.

We conclude that the instant transaction clearly passes muster. Its economics were such that, while tax savings were expected to -- and did -- accrue to Partnership investors in the early years, at some point a "turn around" would be -- and was -- reached whereby depreciation and interest deductions would be less than income from the leases, and the investors would have to pay taxes on the Partnership profit. Consequently, the estimated net tax savings over the Partnership life -- $ 14,324 for a 70-percent taxpayer ⁴⁴ -- were considerably less than the investor's $ 30,000 cash investment. From this we conclude that an investor in this Partnership could not have entered into this transaction solely for its tax benefits. ⁴⁵ The potential for profit, ⁴⁶ on the other hand, was substantial as we have found. We conclude, therefore, that this case is controlled by the result in Frank Lyon1985 U.S. Tax Ct. LEXIS 106">*156 ^{471985 U.S. Tax Ct. LEXIS 106">*157} and that the form of this transaction should be respected.

Both parties attempt to emphasize the significance of our recent opinion in Rice's Toyota World, Inc. v. Commissioner, 81 T.C. 184">81 T.C. 184 (1983), affd. on this issue 752 F.2d 89">752 F.2d 89 (4th Cir. 1985), which involved a computer purchase-and-leaseback arrangement ⁴⁸ on the surface appearing to be similar to the leasing 84 T.C. 412">*439 transaction at issue here. In analyzing the transaction, we indicated that the transaction either had to meet the subjective "business purpose" test, or it had to satisfy a more objective "economic substance" test indicating a "realistic opportunity for economic profit which would justify the form of the transaction." 81 T.C. 184">81 T.C. 202-203 & n. 17. We concluded that neither test had been met 1985 U.S. Tax Ct. LEXIS 106">*158 in that case and that the transaction was a sham. In affirming, the Court of Appeals recently confirmed the use of this test, noting in connection with the "economic substance" inquiry that the most credible estimates in the record indicated that residual value of the computer was not sufficient to earn a profit. The facts in the instant case are clearly distinguishable. We have found to the contrary that a profit was reasonably likely so that the economic substance test has been fairly met.

Respondent's reliance upon Estate of Franklin v. Commissioner, 544 F.2d 1045">544 F.2d 1045 (9th Cir. 1976), affg. 64 T.C. 752">64 T.C. 752 (1975), and Narver v. Commissioner, 75 T.C. 53">75 T.C. 53 (1980), affd. per curiam 670 F.2d 855">670 F.2d 855 (9th Cir. 1982), likewise is misplaced. In both of those cases, the issue was whether nonrecourse debt was properly included in cost basis for 1985 U.S. Tax Ct. LEXIS 106">*159 the property involved in each case. We expressly found a lack of genuine indebtedness because the purchase prices of the properties were not shown to have equaled their fair market values. Under such circumstances, the Court of Appeals indicated in affirming our Estate of Franklin decision that the purported purchaser of the property had no incentive to pay off the nonrecourse note because by abandoning the transaction -- and the property securing the debt -- the taxpayer "can lose no more than a mere chance to acquire an equity in the future should the value of the acquired property increase." 544 F.2d 1045">544 F.2d at 1048.

This "prudent abandonment" test referred to by respondent has no place here where the parties have stipulated that the Partnership paid fair market value for the equipment. ^{491985 U.S. Tax Ct. LEXIS 106">*160} Moreover, the Partnership clearly did not have an incentive to abandon the property when it had entered into leases virtually guaranteeing that monthly debt payments would be made, 84 T.C. 412">*440 either where the leases ran their full course or where they were terminated prematurely. ^{501985 U.S. Tax Ct. LEXIS 106">*161}

Respondent's position is simply not supported by the record in this case. The transactions were genuine leases for all purposes including Federal income tax. ^{511985 U.S. Tax Ct. LEXIS 106">*162} We hold for petitioners on this issue. ^{521985 U.S. Tax Ct. LEXIS 106">*163}

In view of our holding that the Partnership is the true owner of the equipment for tax purposes, we now must address the second issue: Whether the Partnership's payment to E.F. Hutton of $ 102,000 as a commission for obtaining offers to 84 T.C. 412">*441 purchase Partnership units was properly amortized over a 9-year period.

There appears to be no dispute between the parties that fees incurred by partnerships for syndication of their shares are nondeductible expenses which must be capitalized. Blitzer v. United States, 231 Ct. Cl. 236">231 Ct. Cl. 236, 684 F.2d 874">684 F.2d 874 (1982); Derr v. Commissioner, 77 T.C. 708">77 T.C. 708, 77 T.C. 708">733-734 (1981); 1985 U.S. Tax Ct. LEXIS 106">*164 Kimmelman v. Commissioner, 72 T.C. 294">72 T.C. 294, 72 T.C. 294">304-306 (1979). See 4A J. Mertens, Law of Federal Income Taxation, sec. 25.35, at 177 (1979 rev. & Supp. 1984). The question before us is what is the proper treatment of these capitalized costs. Petitioners contend that the Partnership should be permitted to deduct them in equal amounts annually over the Partnership's 9-year life. Respondent, on the other hand, asserts that amortization is inappropriate and that, while these costs must be capitalized, they may only be recovered upon liquidation of the Partnership. This Court has not yet decided whether amortization of syndication expenses is appropriate.

In the absence of precedent directly on point, we look to the rule in a closely analogous context. Fees paid by corporations in connection with stock issues (such as brokers' commissions) historically have been treated as a reduction of the capital received by the corporation upon issuance of its stock. Surety Finance Co. of Tacoma v. Commissioner, 77 F.2d 221">77 F.2d 221 (9th Cir. 1935), affg. 27 B.T.A. 616">27 B.T.A. 616 (1933); Barbour Coal Co. v. Commissioner, 74 F.2d 163">74 F.2d 163 (10th Cir. 1934), cert. denied 295 U.S. 731">295 U.S. 731 (1935); Simmons Co. v. Commissioner, 33 F.2d 75">33 F.2d 75 (1st Cir. 1929), 1985 U.S. Tax Ct. LEXIS 106">*165 affg. 8 B.T.A. 631">8 B.T.A. 631 (1927), cert. denied 280 U.S. 588">280 U.S. 588 (1929). Accordingly, such expenses always have been held to be nonamortizable. The rationale for this rule was explained by the U.S. Court of Appeals for the Tenth Circuit, as follows:

the function and scope of this [amortization] statute is to allow a deduction for the exhaustion of assets such as machinery, buildings, or other forms of personalty which depreciate through wear and tear. It has no application here because the expenditure in question was not to acquire property of that kind, but for capital in the form of cash for use in the business. It was not an exhaustible or depreciable asset. But it is said that the right to use the money thus acquired was a property right which is exhausted ratably with the passage of time and consequently an aliquot part of the expenditure made in acquiring it should be allowed as a deduction by way of exhaustion for each year during that period. The argument overlooks the controlling consideration that such a commission is a capital expenditure to be charged 84 T.C. 412">*442 against the proceeds of the stock, not recovered from operating earnings. It merely reduces the net returns from the sale of 1985 U.S. Tax Ct. LEXIS 106">*166 the stock and reduces the available capital. It has no relation to operating expenses. It is equivalent for income tax purposes to the sale of stock at a discount. There can be no substantial difference between the two. The discount in the one instance represents the difference between the par value of the stock and the amount received for it; the commission represents that difference in the other. A capital expenditure cannot be charged income. [74 F.2d 163">Barbour Coal Co. v. Commissioner, supra at 164.]

In 1954, section 248 was enacted as part of the new Code, permitting corporations to elect to amortize organizational expenses over a period of 60 months or more. Pub. L. 83-591, 68A Stat. 76. However the legislative history of this section indicates that it is not applicable to fees paid by the corporation in connection with stock issues, in conformity with prior case law and generally accepted practice, since such fees were not considered to be of an amortizable character. H. Rept. 1337, 83d Cong., 2d Sess. 31, A64 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 37, 224 (1954). See sec. 1.248-1(b)(3)(i), Income Tax Regs. We see no reason not to follow the rule applied in the corporate 1985 U.S. Tax Ct. LEXIS 106">*167 context, particularly in view of the close similarity between the types of expenses incurred by partnerships and corporations in the course of raising capital. ⁵³ Accordingly, we hold that these Partnership syndication costs may not be amortized.

The propriety of our holding is confirmed by the fact that Congress as part of the Tax Reform Act of 1976 enacted new section 709 to the Code. Pub. L. 94-455, 90 Stat. 1547. Section 709(a), which was enacted after the instant syndication fees were incurred 1985 U.S. Tax Ct. LEXIS 106">*168 and paid, provides as follows:

SEC. 709(a). General Rule. -- Except as provided in subsection (b), no deduction shall be allowed under this chapter ⁵⁴ to the partnership or to any 84 T.C. 412">*443 partner for any amounts paid or incurred to organize a partnership or to promote the sale of (or to sell) an interest in such partnership.

This new section was designed primarily to bring the treatment of "guaranteed payments" made to general partners for services rendered in connection with syndication and organization of limited partnerships in conformity with the treatment of similar expenses by corporations. S. Rept. 94-938, at 94, 1976-3 C.B. (Vol. 3) 132. ^{551985 U.S. Tax Ct. LEXIS 106">*170} In codifying existing case law that such payments to partners were not deductible, the House report noted without comment the rule discussed above concerning the "netting" of stock issuing expenses. H. Rept. 94-658, at 121 n. 4, 1976-3 C.B. (Vol. 2) 813. There is no indication in the legislative history that Congress believed that it was changing the law or that partnership syndication fees had previously received different treatment from stock issuing expenses and been amortizable. Moreover, while it is not entirely clear whether the nondeductibility 1985 U.S. Tax Ct. LEXIS 106">*169 provision of section 709(a) is applicable to syndication fees incurred and paid during 1975 ⁵⁶ (such as those before us), nevertheless Congress has seen fit to preclude such deductions at least for all years thereafter. In view of Congress' clear awareness of prior case law both in the partnership and corporate contexts and its apparent intent generally to codify that law, we do not think that a different rule should be applied to the syndication fees before us.

We are aware that the Court of Claims recently held that a "front-end" administrative management fee which was in part "ancillary to the organization of the limited partnership and 84 T.C. 412">*444 syndication of its shares" was not currently deductible but was "a capital 1985 U.S. Tax Ct. LEXIS 106">*171 expenditure to be amortized over the (50 year) life of the partnership." Blitzer v. United States, 231 Ct. Cl. 236">231 Ct. Cl. 236, 684 F.2d 874">684 F.2d 874, 684 F.2d 874">893 (1982). However, we do not feel compelled to follow that ruling, despite our respect for the decisions of that court. Respondent conceded in Blitzer not only that capitalization of these fees was appropriate (as he does here), but also that, at most, amortization over the partnership's 50-year life was called for, a position argued by respondent here to be incorrect. Thus the Court of Claims did not have to address the amortization question in an adversarial context, nor did it approach the issue from a legal standpoint: It reached the conclusion argued for by respondent in the alternative. ^{571985 U.S. Tax Ct. LEXIS 106">*172}

Accordingly, we conclude that respondent correctly determined that the Partnership could not amortize its syndication costs.

Decisions will be entered under Rule 155.

APPENDIX A

Below is a list of petitioners in this consolidated proceeding, along with their places of residence when their petitions were filed and the number of Partnership units owned by them.

84 T.C. 412">*446