nonrecourse notes; (5) whether the partnerships are entitled to depreciation deductions under the income-forecast method; (6) whether each petitioner is entitled to an investment credit; and (7) whether petitioners are subject to an increased rate of interest under section 6621(d) (now section 6621(c))4 for substantial underpayments attributable to tax-motivated transactions. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. Petitioners Guy B. Bailey, Jr., and Lois M. Bailey resided in Coral Gables, Florida, when their petition was filed. Petitioners Norman B. Levy and Helene Levy resided in Woodland Hills, California, at the time their petition was filed. Petitioners Bernard B. Neuman and Miriam Neuman resided in Skokie, Illinois, when their petition was filed. Petitioners Henry Milgram and Toby Milgram resided in Penn Valley, Pennsylvania, and Bala Cynwyd, Pennsylvania, respectively, at the time their petition was filed. Petitioners Henry Milgram and Carol Milgram resided in Penn Valley, Pennsylvania, at the time their petition was filed. Petitioners William Milgram and Harriet Milgram resided in Boca Raton, Florida, and Elkins Park, Pennsylvania, respectively, at the time their petition was filed. Petitioner William Milgram resided in Boca Raton, Florida, when his petition was filed. Petitioners William Milgram and Joyce Milgram resided in Boca Raton, Florida, when their petition was filed. On their pertinent Federal income tax returns, petitionerhusbands as partners in Persky-Bright and Vista claimed deductions and investment tax credits. Respondent disallowed the claimed deductions and investment credits on a variety of grounds. *Former sec. 6621(d) was redesignated as sec. 6621(c) pursuant to sec. 1511(c), Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2744. We will use the reference to the Internal Revenue Code as redesignated and amended. Background Persky-Bright and Vista are two of a number of film partnerships organized by Lester Persky (Persky) and Richard Bright (Bright). Persky, after an advertising and public relations career, was involved with the production of several motion pictures in the late 1960s. Bright was experienced in the fields of taxation and cash management, and was a financial advisor who specialized in agricultural and real estate investments before joining forces with Persky. They met in 1971, when Persky was attempting to find an American distributor for two foreign films. They became the general partners of a limited partnership which purchased the two films. Persky and Bright were not satisfied with the independent distributor of those films. In 1973, Columbia Pictures, Inc. (Columbia), a major distributor, was in desperate financial condition, nearing bankruptcy. It had experienced operating losses in excess of $100 million during the prior 3 years and had an approximate net worth of only $8 million. Columbia was over $250 million in debt and the banks refused to extend any further credit. The banks insisted on a change of management. Burton Marcus (Marcus), a tax lawyer, became the vice president and general counsel of Columbia. He and several other new operating officers determined that Columbia's most potent source of cash was through the distribution of films and that they would not give up the right to distribute their films. They estimated that approximately $40 million was needed to produce the films they wanted to distribute. Columbia had $25 million at the time. To raise part of the difference, Columbia sold its corporate headquarters building at a bargain price of $11 million, its television stations in Salt Lake City, New Orleans, and Puerto Rico, and its Learning Corporation. To raise additional funds, Marcus decided to develop a program to sell films.5 After doing a cost analysis, Marcus decided that he would price the films at warranted cost plus at least a 25-percent markup. 5Use of terms such as "sell," "buy," "purchase," "acquire," "interest," "principal," and "price" should not be construed as carrying any conclusion as to the legal effect of the documents or transactions involved herein. The first film Columbia decided to sell was "Summer Wishes, Winter Dreams." Marcus learned that Persky and Bright wanted to buy the film. In late 1973, Marcus met with Persky and Bright to arrange the sale of "Summer Wishes, Winter Dreams" to Persky-Bright. Persky and Bright did not have any independent projections of profit made before contracting for the film. In 1974, Marcus met with Persky and Bright to arrange the sale of a package of four films to Vista, the other partnership involved in this case. Again, Persky and Bright did not have any independent projections of profit made before contracting to buy the film package. Ultimately, Columbia sold 10 to 15 films to partnerships organized by Persky and Bright. I Persky-Bright Persky-Bright is a New York limited partnership formed on October 15, 1973. Persky and Bright are the general partners, each owning a 2.5-percent interest in the profits and losses and a 0.5-percent interest in the investment tax credit and 2.5-percent interest in the cash-flow of the partnership. Persky and Bright prepared an informal offering memorandum for prospective partners. The memorandum was similar to the offering memorandum prepared in connection with the formation of the Vista partnership. During the years in issue, the limited partners held in aggregate a 95-percent interest in the profits and losses and a 99-percent interest in the investment tax credit. The total capital contributed to Persky-Bright by its partners was $465,000, of which $300,000 was contributed in 1973, and $165,000 was contributed in 1974. The film "Summer Wishes, Winter Dreams" stars Joanne Woodward, Martin Balsam, and Sylvia Sydney. It was produced by Jack Brodsky and directed by Gilbert Cates. The story concerns a middle-aged woman who must cope with the disappointments of her life, such as an unfulfilling marriage, a nagging mother, and a son who is gay. The movie dramatizes the problems and conflicts within the family. The film was rated PG by the Motion Picture Association of America's Classification and Ratings Administration. Persky and Bright viewed "Summer Wishes, Winter Dreams" prior to its purchase. "Summer Wishes, Winter Dreams" was completed and edited prior to October 15, 1973, the date on which Persky-Bright was formed. Persky-Bright and Columbia executed simultaneous purchase and distribution agreements with respect to "Summer Wishes, Winter Dreams" on October 15, 1973. On that date, Persky-Bright entered into an agreement with Columbia to purchase all rights, title, and interest in "Summer Wishes, Winter Dreams" for a total purchase price of $2 million. Pursuant to this agreement, PerskyBright acquired legal title and ownership of the copyright and negative of the film. The purchase price was based on 133 percent of the amount Columbia warranted as the production cost of the film, which was no less than $1.5 million. In determining negative cost during 1973, a factor of 15 percent of the direct production costs would ordinarily represent overhead costs. Persky-Bright was able to negotiate a 5-percent overhead cost in its purchase agreement. The completed production cost of "Summer Wishes, Winter Dreams" was as follows: The purchase agreements provided for payment of the $2 million purchase price as follows: Upon execution of the agreement..... On or before 12/15/73 On or before 9/15/74. $75,000 and delivery of a $1,850,000 nonrecourse promissory note $50,000 In addition, Persky-Bright agreed to pay interest on the note on December 15, 1973, and September 15, 1974, in the amounts of $125,000 and $100,000, respectively. The prom "The purchase agreement was amended on or about June 24, 1974, with respect to other provisions. issory note was due 10 years from the date of the agreement and bore interest at the rate of 12 percent for the first year and 10 percent thereafter. On October 15, 1973, Persky-Bright paid Columbia $75,000 representing its initial payment of the purchase price. On December 15, 1973, pursuant to the above provisions, Persky-Bright paid $150,000, of which $25,000 represented a payment of the purchase price and $125,000 represented a payment of interest. On September 15, 1974, pursuant to the above provisions, Persky-Bright paid $150,000, of which $50,000 represented payment of the purchase price and $100,000 represented interest. The nonrecourse note was secured by a first lien on the film and a security interest in the revenues derived from the film. Columbia was to be paid 75 percent of the distributable gross receipts after various deductions until it had received in full the principal amount of the note together with interest, with the remaining 25 percent to be paid to Persky-Bright. All such payments to Columbia were to be credited first to interest and then to principal. On October 15, 1973, Persky-Bright also entered into an agreement with Columbia under which Columbia had the exclusive right to distribute "Summer Wishes, Winter Dreams" for a period of 10 years. It was anticipated by all concerned that a film would produce most of its revenues in the first 2 years of showing and would have a useful life of about 10 years. The agreement, as amended on June 24, 1974, gave Columbia an option to extend its distribution rights in perpetuity by paying the greater of $15,000 or the fair market value of the distribution rights at the time the distribution rights were extended. The fair market value for such an extension was to be based on the average price paid by Columbia to extend the term of agreements relating to the distribution of comparable pictures pursuant to which agreements Columbia had acquired the distribution rights for a 10-year term and had exercised a right to extend the term in perpetuity. The agreement provided that Persky-Bright had the right to approve the overall sales and advertising policy in connection with "Summer Wishes, Winter Dreams" and to |