is anticipated that certain proceeds of this offering will be invested in the senior position of a movie, 'The Bluebird.'' By offering circular dated May 22, 1974, units were offered in the Wenles limited partnership. Rockefeller Industries, a corporation owned by Blum, handled the offering. Blum and ROHA Corp., organized Wenles and served as general partners. The offering circular states that Wenles was formed to acquire and own the rights to a motion picture based on "The Bluebird" by Maurice Maeterlinck. The Wenles offering circular states, in pertinent part:

The units offered by this offering circular are a speculative investment and involve a high degree of risk. In analyzing such an investment, prospective investors should consider carefully, among other factors, the following:

1. Predicated on Continuation of Detente. "The Bluebird" is being produced under a co-production agreement with the U.S.S.R. and will be filmed in Leningrad, U.S.S.R. The ability to produce and complete "The Bluebird" is dependent upon the world political situation in general and the continuation of the present detente in particular, * . The Partnership will use its best efforts to obtain insurance against political problems which might effect [sic] the production or completion of the picture. Such insurance, if obtainable at all, would merely provide for recoupment of investment. There is no assurance that dramatic changes will not occur on the world scene prohibiting this production or otherwise resulting in a complete loss of the total investment.

2. Unpredictable Factors in Motion Picture Industry. These units should not be purchased unless the investor is prepared for the possibility of a total loss. Investment in motion picture production involves a substantial degree of risk. Recoupment of invested capital and the possibility of profit are largely functions of a motion picture's cost of acquisition, development, production and distribution in relation to its ultimate audience appeal, which may depend, among other things, upon unpredictable critical reviews and changeable public tastes, which cannot be ascertained in advance with any reasonable degree of certainty. Industry figures indicate that many motion picture productions do not achieve profitability.

3. Dependence on Distributor and its Compensation. Success of a motion picture may be dependent in large part upon the efforts, advertising and publicity expenditures of its distributor or distributors. The distribution of motion pictures is highly competitive; distributors compete with each other for suitable theatrical and non-theatrical outlets,

*. A distributor of a motion picture may at the same time be engaged in distributing motion pictures owned by such distributor or in which it has varying profit interests and investments,

Additionally, the Wenles offering circular states:

Tax Consequences. The Partnership will acquire the ownership of all rights to exploit the film and its ancillary products (the "property") under existing Federal income tax laws and regulations, the partners, rather than the Partnership itself, will be taxed upon all profits and receive all deductions, generated by the Property.

The Partnership will use the cash method of accounting, reporting income when received and taking deductions when amounts are paid.

It is anticipated that the Partnership's basis of approximately $2,368,000 for depreciation and investment credit will be based upon the contract price of (i) $2,200,000 which it is obligated to pay Bluebird Productions, Ltd. for the making of the film; (ii) upon the Partnership's cash payment of $150,000 for acquisition of the rights and reimbursement for the developmental expenses; and (iii) upon $18,000 for organizational costs of the Partnership.

Depreciation will be taken based upon the "income forecast" method, which the Internal Revenue Service has accepted for use with motion pictures. Under this method, the cost of the film will be amortized based upon the amount of income which it generates in the current year compared to the total anticipated income to be generated over the life of the film. This depreciation will not commence until the film is put into distribution. In order to comply with the investment tax credit requirements imposed by the Revenue Act of 1971 to obtain a maximum credit, no more than 76% of the depreciable basis will be written off in the first three (3) years, nor more than 97% in the first five (5) years.

A tax opinion letter written by Steven L. Kadish (Kadish) and dated May 22, 1974, accompanied the offering circular and stated:

Each Limited Partner's basis for his Partnership interest will be the total of the cost of the following:

(1) the acquisition of cinematographic film and ancillary rights and of the reimbursement for development of the screenplay and music;

(2) the contract with the production service company for production and delivery of a completed film; and

(3) certain organizational costs.[9]

Finally, the offering circular set forth the financing for the production, repayment, and profit participation of "The Bluebird" as follows:

"The opinion letter also stated that the contract price paid to BBP for its production services was a "bonafide fair market amount" incurred and paid in a "bonafide fair market transaction."

(1) To Bluebird Productions, Ltd.

The loans and investments are to be repaid solely from the American co-producer's revenues in the following order of priority, prior to any profit participation.

After these recoupments, all additional revenues received by the American co-producer will be distributed to the respective participants in the producer's group. [Fn. ref. omitted.]

In this regard, the offering circular stated that Blum and Greenberg were under contractual agreement to obtain and deliver by June 7, 1974, the following:

(a) $265,000 to acquire ownership of the picture; and (b) $235,000 to produce the picture; and

(c) $250,000 of senior financing.

The financing transactions for the film "The Bluebird" were set up sometime in late 1974.10 First, by agreement of sale, ELP sold its literary rights in "The Bluebird" to Wenles. This agreement excluded the sale of the "pay television rights." Wenles agreed to pay ELP $150,000 plus an additional amount set forth in a disbursement of revenues agreement for the rights to "The Bluebird."'11

Second, Wenles entered into a production agreement with Bluebird Productions, Ltd. (hereinafter BBP), an Illinois partnership. Under the production agreement, Wenles stated that it "has entered into agreements to acquire

10 Petitioners contend that the agreements were signed on Aug. 27, 1974. However, it is not clear to this Court on the record before us that all the agreements in question were indeed signed on that date. In fact, the agreement of sale between ELP and Wenles contain references to certain agreements whose dates remain blank. Moreover, documents dated Aug. 27, 1974, contain sheets with later dates on the bottom of the page. As a result, we cannot find that these agreements were executed on Aug. 27, 1974, although we do find that they were executed sometime in late 1974.

"Lewis personally guaranteed the performance of ELP under the purchase agreement.

ownership of a full-length feature motion picture in preparation tentatively entitled "The Bluebird." The parties acknowledged that BBP had already committed funds and secured commitments from distributors and other financing entities for additional loans in financing the performance of BBP's services. The salient features of the production agreement are as follows:

Contractor [BBP] shall perform all non-U.S.S.R. functions necessary to prepare a negative and other materials of the Picture These functions are to be performed as to fulfill the non-U.S.S.R. obligations of a co-production Agreement of December 5, 1973, with the U.S.S.R. Sovinfilm (the "Co-Production Agreement") to which agreement Contractor became a non-U.S.S.R. party after the foregoing date, and the obligations of Owner [Wenles] under a letter agreement (the "Distribution Agreement") of even date between Owner and Twentieth Century-Fox Film Corp. ("Fox"), which will be replaced by a more definitive agreement at a later date.

Contractor [BBP] covenants that it will engage the services of EDWARD LEWIS as producer, and GEORGE CUKOR as director of the Picture. In connection with substitutes for Cukor or the principal talent, Contractor shall give Fox the rights of consultation and approval set forth in the Distribution Agreement.

*

Owner [Wenles] shall pay Contractor [BBP] $115,000 upon execution of this Agreement; and upon acceptance of the Picture shall pay or cause to be paid to Contractor or its designees as full compensation for Contractor's services hereunder, the further sum of $2,535,000 solely out of the monies received by Owner from the exploitation of the Picture, as provided in that certain Disbursement of Revenues Agreement dated the date hereof (the "Disbursement of Revenues Agreement") among Owner, Contractor and certain other parties.

As a condition precedent to Contractor's obligations hereunder, Contractor shall be provided with (a) an overbudget guaranty of the American costs in form and from a party satisfactory to Contractor; and (b) non-recourse loans to Contractor in amounts aggregating the difference between Contractor's investment of $235,000 and the Budget (excluding from the Budget for the purposes of this computation the contract price paid by Owner plus development expenses paid by Owner to Edward Lewis Productions, Inc. and any and all contingent deferments).

[Emphasis supplied.]

Pursuant to this production agreement, BBP and ELP entered into a production services agreement whereby ELP would provide the services which would comply with the

production agreement between BBP and Wenles, the coproduction agreement with ELP and Sovinfilm, and the distribution agreement with Fox.12 In consideration for ELP's services, BBP agreed to pay ELP (a) $82,500 during the production of the film; (b) $117,500, payable as a contingent deferment; and (c) such other sums payable to ELP under the disbursement of revenues agreement.

Third, Wenles, BBP, ELP, and Twentieth-Century Fox Films, Ltd. (Fox), entered into an agreement which acknowledged that ELP, as guarantor of the picture, received the sum of $1,600,000 as budget costs of the picture. This guaranty agreement states, in pertinent part:

In consideration of the fee to be paid to the Guarantor [ELP] as set forth in the Budget, *** the parties hereto hereby agree as follows:

1. On condition that

(a) Parties other than Guarantor have made available to ELP under a Production Services Agreement of even date the sum of $1,350,000, plus $250,000 which will be made available upon delivery of an answer print to Distributor (the "sum") which sum shall be utilized to pay the U.S.-side costs set forth in the Budget referred to above;

(b) Edward Lewis, or if Edward Lewis should be unable or unwilling so to act, his duly appointed successor, is irrevocably empowered to exercise all artistic controls and production controls with respect to the production and completion of the Picture ***

the Guarantor hereby agrees, on notice from Owner, BBP or Distributor, to procure or provide all dollar costs of production of the Picture paid or incurred in excess of the Budget

5. Any sums advanced by Guarantor hereunder shall be in the form of non-recourse loans to BBP and shall be repaid to it solely as provided in the Disbursement of Revenues Agreement.

6. This agreement is made by Guarantor for the benefit of Owner [Wenles], BBP, Cinema Ventures, Ltd., Worldwide Productions, Ltd. and Distributor [Fox] *** [Emphasis supplied.]

Furthermore, the guaranty agreement stated:

8. As security for the repayment to Guarantor of such sums as it may expend pursuant to this instrument, the Owner will execute in favor of the Guarantor and will deliver to the Guarantor all such security

12Sometime during the period from 1972 through 1974, Lewis of ELP presented "The Bluebird" package (the script and various elements) to Gordon Stohlberg, president of Twentieth Century Fox Film Corp. There was great interest in the project on behalf of Fox. However, as of the time that this agreement was executed, it is clear that no formal distribution agreement existed with Twentieth-Century Fox Films, Ltd. In this regard, the production services agreement states "It is contemplated that the distribution agreement, which is now in letter agreement form, will be replaced by a more formal agreement."