K-K Restaurants, Inc. (98-2417) v. Commissioner of Internal Revenue

16 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
failure to make a reasonable attempt to comply with the
provisions of this title . . . .” I.R.C. § 6662(c). It has also
been defined as a “lack of due care or a failure to do what a
reasonable and prudent person would do under the
circumstances.” Hofstetter v. Commissioner, 98 T.C. 695,
704 (1992). We find and conclude that Petitioners allocated
BKK’s management fees on the ability of each Group
member to pay.
1
RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206
ELECTRONIC CITATION: 2000 FED App. 0057P (6th Cir.)
File Name: 00a0057p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
_________________
KENCO R ESTAURANTS, INC.
(98-2416); K-K
R ESTAURANTS, INC.
(98-2417); TIFFIN AVENUE
R EALTY C OMPANY , INC.
(98-2418); BRYAN R EALTY ,
INC. (98-2420),
Petitioners-Appellants,
v.
C OMMISSIONER OF INTERNAL
R EVENUE ,
Respondent-Appellee.
;>

1
Nos. 98-2416/
2417/2418/2420
On Appeal from the United States Tax Court.
Nos. 95-15949; 95-15950; 95-15951; 95-15952
Argued: December 10, 1999
Decided and Filed: February 16, 2000

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2 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
*The Honorable Dan A. Polster, United States District Judge for the
Northern District of Ohio, sitting by designation.
Before: BOGGS and SUHRHEINRICH, Circuit Judges;
POLSTER, District Judge.*
_________________
COUNSEL
ARGUED: John D. Steffan, STEFFAN & ASSOCIATES,
Fairfax, Virginia, for Appellants. Charles F. Marshall, U.S.
DEPARTMENT OF JUSTICE, APPELLATE SECTION
TAX DIVISION, Washington, D.C., for Appellee.
ON BRIEF: John D. Steffan, STEFFAN & ASSOCIATES,
Fairfax, Virginia, for Appellants. Charles F. Marshall, Teresa
E. McLaughlin, U.S. DEPARTMENT OF JUSTICE,
APPELLATE SECTION TAX DIVISION, Washington, D.C.,
for Appellee.
_________________
OPINION
_________________
SUHRHEINRICH, Circuit Judge. The Commissioner of
the Internal Revenue Service (“Commissioner”) sent
Petitioners notices of deficiency that reallocated fees
Petitioners paid for management and administrative services.
The notices of deficiency also imposed accuracy-related
penalties. Petitioners filed separate petitions in the United
States Tax Court seeking a redetermination of the deficiencies
and accuracy-related penalties.
The tax court sustained the reallocations and penalties
because Petitioners failed to overcome the presumption of
correctness afforded to the notices of deficiency. Petitioners
appeal. We AFFIRM.
Nos. 98-2416/
2417/2418/2420
Kenco Restaurants, et al.
v. Commissioner
15
5The Tax Court suspected “that Wapak’s insufficient cash-flow was
the determinant factor in BKK’s management decision not to allocate
Wapak a management fee in 1990.” We agree.
so did its fees.5 GMK’s fees increased more than 900%
between 1990 and 1992, and its share of the total fees
increased by a factor of seven. However, no evidence was
presented that there was a corresponding increase in Owner
hours. In 1990, Kenco required special attention to rebuild
the restaurant. Yet, in 1991, the fee allocated to it was higher
than 1990. There is no claim that K-K required special
attention in 1992, but its fee was higher in 1992 than in 1991.
Perrysburg was charged $29,000 in 1990, $60,415 in 1991,
and $42,700 in 1992, but Petitioners provided no explanation,
in terms of services, that would account for these differences.
The third issue we address is whether Petitioners are liable,
under § 6662(a) of the Internal Revenue Code, for accuracy-
related penalties due to their negligence. Petitioners contend
that the facts do not support the imposition of negligence
penalties because Petitioners never made adjustments based
upon the ability or inability of a Group member to pay.
However, the Commissioner contends that Petitioners
allocated fees based on each Group member’s ability to pay.
We review an imposition of § 6662(a) “negligence”
penalties for clear error. See Leuhsler v. Commissioner, 963
F.2d 907, 910 (6th Cir. 1992); see also Sacks v.
Commissioner, 82 F.3d 918, 920 (9th Cir. 1996).
“Commissioner’s assessment of a negligence penalty is
presumptively correct, and the taxpayer has the burden of
proving that an underpayment was not due to his negligence
. . . .” Leuhsler, 963 F.2d at 910.
If there is an underpayment of tax on a return, a penalty in
the amount of twenty percent of the underpayment is
imposed. See I.R.C. § 6662(a). This applies to the portion of
the underpayment that is attributable to negligence. See
I.R.C. § 6662(b)(1). “Negligence” is defined to include “any

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14 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
Petitioners must show that their own allocations reflect an
arm’s-length charge. See DHL Corp. & Subs. v.
Commissioner, 76 T.C.M. (CCH) 1122, 1145 (1998); see also
Treas. Reg. § 1.482-1(b). This is accomplished by providing
evidence of similar transactions between uncontrolled
taxpayers. See Lufkin Foundry & Machine Co., 468 F.2d at
808; see also Treas. Reg. § 1.482-2(b)(3).
For this first burden, the Commissioner is not required to
support the notice of deficiency with proof because courts
generally do not examine the underlying motives or policy of
the Commissioner’s determination. See Pasternak v.
Commissioner, 990 F.2d 893, 898 (6th Cir. 1993). Also,
when determining whether the Commissioner’s reallocation
is reasonable, courts focus on the reasonableness of the result
and not the details of the methodology employed. See
Seagate Tech., Inc. & Consol. Subs. v. Commissioner, 102
T.C. 149, 164 (1994); see also Bausch & Lomb, Inc. v.
Commissioner, 92 T.C. 525, 582 (1989).
Under the second burden, which only arises after
Petitioners have satisfied the first burden, Petitioners “still
have the burden of proving that their own allocation satisfies
the arm’s length standard.” Inverworld, Inc. v.
Commissioner, 71 T.C.M. (CCH) 3231, 3237-62 (1996); see
also Achiro v. Commissioner, 77 T.C. 881, 900 (1981). If
Petitioners fail to carry this burden, the tax court must
determine a proper allocation based on the record. See
Inverworld, Inc., 71 T.C.M. (CCH) at 3237-62 (citing Eli
Lilly 7 Co, 856 F.2d at 860).
We conclude that Petitioners’ allocations are not an arm’s-
length charge because Petitioners provide no evidence of an
independent transaction between unrelated parties in similar
circumstances. Also, the facts support our conclusion that
Petitioners were not dealing at arm’s length but were, instead,
allocating their costs based on an ability to pay. Petitioners
charged Wapak, a Restaurant Corporation, no management
fee in 1990, but when its income increased in 1991 and 1992,
Nos. 98-2416/
2417/2418/2420
Kenco Restaurants, et al.
v. Commissioner
3
I.
Petitioners-Appellants, Kenco Restaurants, Inc. (“Kenco”);
K-K Restaurants, Inc. (“K-K”); Tiffin Avenue Realty Co.,
Inc. (“Tiffin”); and Bryan Realty, Inc. (“Bryan”) (collectively
“Petitioners”), are members of a commonly owned group of
fourteen corporations (collectively “Group”). During the
years 1990 through 1992, George Kentris (“G. Kentris”),
Michael Kentris (“M. Kentris”), and Kenneth Baerwaldt
(“Baerwaldt”), either individually or with their wives
(collectively “Owners”), owned equal shares of the Group.
Of the fourteen Group members, thirteen either own and
operate one or more Taco Bell restaurants (“Restaurant
Corporations”) or own the real estate (“Realty Corporation”)
on which another member of the Group operates a Taco Bell
restaurant. The following is a chart identifying the thirteen
Restaurant and Realty Corporations:
Restaurant Realty
Corporations Location Corporations
K-K Findlay, OH Tiffin
K-K Findlay, OH Trenton Ave. Realty
Kenco Lima, OH Harding Highway Realty
Kenco Lima, OH Allentown Road Realty
Bowling Green Bowling Green, OH Bowling Green
GMK Defiance, OH unrelated corporation
Perrysburg Perrysburg, OH Perrysburg
Wapak Wapakoneta, OH Apollo Drive Realty
Bryan Rest. Bryan, OH Bryan
The fourteenth Group member, BKK Management, Inc.
(“BKK”), neither owns a Restaurant Corporation nor owns a
Realty Corporation. Instead, BKK provides management and
administrative services to the thirteen Group members and
bills each Group member for these services. These services
are not in dispute and, according to the tax court’s opinion,
include “accounting and administrative services, advertising,
coordination and installation of Taco Bell menus,
renovations, remodeling and repairs, building and equipment

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4 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
maintenance, insurance coverage, training, inspections, and
contracting.” Kenco Restaurants, Inc. v. Commissioner, 76
T.C.M. (CCH) 512, 513 (1998). The services are performed
by Owners and BKK’s support staff, and BKK pays their
salaries. Baerwaldt and M. Kentris provide the operational
management of the restaurants, and G. Kentris, an attorney,
works half as many hours as the former two and is responsible
for the Group’s administrative and legal needs, which include
payroll, contracts, finances, and legal matters.
All costs that BKK incurs for providing these services are
allocated to Group members as a “management cost share”
fee. These fees have two categories: payroll related (salaries,
employment taxes, and health benefits) and incidental (office
supplies, telephone charges, and rent). Approximately 85
percent of BKK’s payroll related costs are attributable to
Owners, and approximately 15 percent are attributable to the
support staff.
Petitioners contend that BKK’s payroll related costs were
allocated according to the number of hours each Owner spent
with each Group member. For an upcoming year, the Owners
projected the hours they would spend with each Group
member based on the hours they spent the previous year.
Then, they adjusted their projections for upcoming projects
and reevaluated them at midyear. However, the Owners did
not maintain time logs or written documents recording their
actual hours. Petitioners further contend that BKK allocated
its incidental costs to Group members based on their
consumption.
The fees that Group members paid to BKK are reflected in
the following chart. To the right of each fee is the percentage
that the fee represents of BKK’s total annual fees.
Nos. 98-2416/
2417/2418/2420
Kenco Restaurants, et al.
v. Commissioner
13
Treas. Reg. § 1.482-2(b)(7)(ii)(a).
We conclude that BKK’s performance of services for other
Group members is an “integral part” of its business activity
and that an arm’s-length charge is equal to “the amount which
was charged or would have been charged” for same or similar
services “in independent transactions with or between
unrelated parties under similar circumstances.” Treas. Reg.
§ 1.482-2(b)(3). We reach this conclusion because BKK is a
member of a controlled group and renders services as its
principal activity.
The Group members are members of a “controlled group,”
as used in Treasury Regulation § 1.482-2(b)(7)(ii), because
each Group member is a “controlled taxpayer.” “Controlled
taxpayer” is defined as “any one of two or more
organizations, trades, or businesses owned or controlled
directly or indirectly by the same interests.” Treas. Reg.
§ 1.482-1(a)(4). In the instant case, Petitioners are controlled
taxpayers because it is undisputed that they are commonly
owned corporations and are owned equally by Owners. Also,
BKK renders services to Group members as its principal
activity because the parties have stipulated that the primary
purpose of BKK is to provide services to Group members.
Thus, both the “25 percent test” and the “facts and
circumstances test” of Treasury Regulation § 1.482-2(b)(7)(ii)
are satisfied.
Now that we have defined an arm’s-length charge, we must
next determine whether Petitioners have overcome two
burdens of proof. Under the first burden, Petitioners must
prove that the Commissioner’s reallocations are wrong,
because the notices of deficiency have a presumption of
correctness. See Welch v. Helvering, 290 U.S. 111, 115
(1933). This presumption is overcome if Petitioners prove
that the reallocations contained in the notices of deficiency
are arbitrary, capricious, or unreasonable. See Spicer Theatre
Inc., 346 F.2d at 706; see also Eli Lilly & Co. 856 F.2d at
860. To prove arbitrary, capricious, or unreasonable,

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12 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
3Subdivisions (i) through (iv) describe those situations that are
considered an “integral part of the business activity.” See Treas. Reg.
§§ 1.482-2(b)(7)(i) through (iv).
4Cost of services includes “all costs or deductions directly or
indirectly related to the rendition of such services.” Treas. Reg. § 1.482-
2(b)(7)(ii)(b).
is “the amount which was charged or would have been
charged for the same or similar services in independent
transactions with or between unrelated parties under similar
circumstances considering all relevant facts.” Treas. Reg.
§ 1.482-2(b)(3).
Of the four situations that the regulations consider an
“integral part of the business activity,”3 the most applicable
to the instant facts is Treasury Regulation 1.482-2(b)(7)(ii).
In this section, “[s]ervices are an integral part of the business
activity of a member of a controlled group where the renderer
renders services to one or more related parties as one of its
principal activities.” Treas. Reg. § 1.482-2(b)(7)(ii). Services
are considered “principal activities” if the following two tests
are satisfied. First, the renderer’s cost of services4
“attributable to the rendition of services for the taxable year
to related parties” must exceed “25 percent of the total costs
or deductions of the renderer for the taxable year [25 percent
test].” Treas. Reg. § 1.482-2(b)(7)(ii)(a). Second, the facts
and circumstances determine whether the rendition of services
to related parties is one of the principal activities of the
renderer (“facts and circumstances test”). See Treas. Reg.
§ 1.482-2(b)(7)(ii)(a). The regulations consider six factors:
the time devoted to the rendition of the services, the
relative cost of the services, the regularity with which the
services are rendered, the amount of capital investment,
the risk of loss involved, and whether the services are in
the nature of supporting services or independent of the
other activities of the renderer.
Nos. 98-2416/
2417/2418/2420
Kenco Restaurants, et al.
v. Commissioner
5
**Petitioners on appeal.
1Camper testified that she used the gross sales method because
Petitioners provided no actual time logs or any other information from
which Camper could calculate the actual hours Owners spent with each
Group member.
Restaurant Corporations
1990 1991 1992
Kenco** FEE / % 313,700.00/43.0% 413,000.00/42.3% 389,000.00/33.5%
K-K** FEE / % 279,650.00/39% 283,500.00/29% 380,600.00/32.9%
GMK FEE / % 9,100.00/1.0% 21,700.00/2.2% 87,200.00/7.5%
Perrysburg FEE / % 29,000.00/4.0% 60,415.00/6.2% 42,700.00/3.7%
Bowling
Green FEE / % 30,500.00/4.2% 82,000.00/8.4% 112,000.00/9.7%
Wapak FEE / % 0.00/0.0% 29,600.00/3.0% 52,366.00/4.5%
Bryan
Rest. FEE / % --------- --------- 6,000.00/0.5%
Realty Corporations
1990 1991 1992
Tiffin** FEE / % 28,000.00/3.9% 31,000.00/3.2% 26,000.00/2.2%
Trenton FEE / % 12,000.00/1.7% 14,500.00/1.5% 16,100.00/1.4%
Allentown FEE / % 2,000.00/0.3% 8,700.00/0.9% 11,100.00/1.0%
Harding
Highway FEE / % 18,000.00/2.5% 24,000.00/2.5% 25,000.00/2.2%
Apollo FEE / % 3,000.00/0.4% 7,700.00/0.8% 7,200.00/0.6%
Bryan** FEE / % --------- --------- 3,000.00/0.3%
After an audit, IRS Agent Camper (“Camper”) calculated
the reallocations of BKK’s management fees to reflect each
Group member’s yearly gross sales.1 These reallocations
decreased the share of BKK fees claimed by each Petitioner
and thus decreased each Petitioner’s deductions.
Consequently, the lowered deductions increased each
Petitioner’s taxable income and created a disparity between

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6 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
the taxable income as represented by Petitioners and the
taxable income as represented by the Commissioner’s
reallocations. The notices of deficiency that the
Commissioner mailed separately to each Petitioner on June
13, 1995, reflect this disparity. The deficiencies and their
accuracy-related penalties (20 percent) are illustrated in the
following chart:
Petitioners Year Deficiency Penalty Total
Kenco 1990 $36,664.00 $7,333.00 $43,997.00
Kenco 1991 23,068.00 4,614.00 27,682.00
K-K 1990 35,056.00 7,011.00 42,067.00
K-K 1991 18,962.00 3,792.00 22,754.00
K-K 1992 21,304.00 4,261.00 25,566.00
Tiffin 1990 4,772.00 954.00 5,726.00
Tiffin 1992 4,124.00 825.00 4,949.00
Bryan 1992 174.00 35.00 209.00
TOTAL $184,435.00 $36,887.00 $221,323.00
On August 18, 1995, Petitioners filed separate petitions in
the United States Tax Court for a redetermination of the
deficiencies and accuracy-related penalties. These petitions
were consolidated at trial.
At trial, the Commissioner retained Sharon Moore
(“Moore”), a business valuation expert with Alpha Consulting
Alliance, to decide whether BKK’s fee allocations were
consistent with an arm’s-length transaction. Moore
determined that Petitioners’ allocations were not arm’s length
and devised her own time-based allocations. To calculate
these time-based allocations, Moore used the hours that each
Owner and BKK employee spent in performing services for
each Group member, which Moore obtained through
interviews with Owners and BKK employees, rather than
Nos. 98-2416/
2417/2418/2420
Kenco Restaurants, et al.
v. Commissioner
11
2Unless otherwise indicated, all section references are to the Internal
Revenue Code and its Regulations that are in effect for the taxable years
in issue.
order to prevent evasion of taxes or clearly to reflect the
income of any of such organizations, trades, or
businesses . . . .
I.R.C. § 4822.
The “purpose of section 482 is to place a controlled
taxpayer on a tax parity with an uncontrolled taxpayer . . . .”
Commissioner v. First Security Bank of Utah, 405 U.S. 394,
400 (1972). If an arrangement between related parties differs
from those reached in an uncontrolled, arm’s-length dealing,
the Commissioner may reallocate under section 482. See
Lufkin Foundry and Machine Co. v. Commissioner, 468 F.2d
805, 807 n.2 (5th Cir. 1972) (citing Spicer Theatre, 346 F.2d
at 706). This authority includes reallocating charges among
controlled corporations for “marketing, managerial,
administrative, technical, or other services” that do not
represent an arm’s-length charge. See Treas. Reg. § 1.482-
2(b)(1).
Whether the notices of deficiency are arbitrary, capricious,
or unreasonable depends, in part, on whether the charges were
arm’s length. If the charges were equivalent to charges made
at arm’s length, then Petitioners have satisfied their burden of
proving that the notices of deficiency are arbitrary, capricious,
or unreasonable. The regulations of section 482 govern the
definition of an arm’s-length charge.
If BKK’s services are not an “integral part of the business
activity,” then an arm’s-length charge is generally equal to the
costs or deductions incurred in rendering such services. See
Treas. Reg. § 1.482-2(b)(3). However, if BKK’s services are
an “integral part of the business activity,” then the costs or
deductions incurred are not an arm’s-length charge. See
Treas. Reg. § 1.482-2(b)(7). Rather, an arm’s-length charge

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10 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
deficiency are arbitrary, capricious, or unreasonable. Because
deficiency notices have a presumption of correctness,
Petitioners have the burden of overcoming this presumption
by proving that their initial allocations were arm’s length.
Petitioners contend that the Commissioner’s reallocation
method is arbitrary, capricious, or unreasonable for the
following three reasons. First, the Commissioner’s
methodology ignores the special situations that justified
Petitioners’ initial allocations. Second, Petitioners contend
that their fee allocation is reasonable and arm’s length
because it represents the actual time spent on managing and
operating each Group member. Petitioners further argue that
these records were in fact created and monitored even though
they were inadvertently destroyed. Third, Moore, the
Commissioner’s expert, conceded that Petitioners’ method of
allocating time was reasonable because Moore’s method is
identical and differs only as to hours.
The Commissioner contends that Petitioners have failed to
show that the reallocations contained in the notice of
deficiency are arbitrary, capricious, or unreasonable. In the
alternative, the Commissioner contends that assuming we find
the notices of deficiency arbitrary, capricious, or
unreasonable, then Moore’s time-based allocations represent
an arm’s-length charge. For this alternative contention,
Commissioner asserts that Moore’s allocations more properly
reflect value added to each Group member.
Section 482 of the Internal Revenue Code and its
regulations govern the instant case:
In any case of two or more organizations, trades, or
businesses . . . owned or controlled directly or indirectly
by the same interests, the Secretary may distribute,
apportion, or allocate gross income, deductions, credits,
or allowances between or among such organizations,
trades, or businesses, if he determines that such
distribution, apportionment, or allocation is necessary in
Nos. 98-2416/
2417/2418/2420
Kenco Restaurants, et al.
v. Commissioner
7
adopting Petitioners’ method of using only Owner hours.
Moore included the projected hours of a district manager, a
maintenance man, and BKK’s in-house accountant
(“Borsani”). In contrast to Petitioners’ allocations, Moore
weighed Owner and employee hours equally because Moore
found that both Owners and employees performed similar
operational tasks. Moore then converted the total hours
allocated to each Group member into a corresponding fee
allocation and concluded that her time-based allocations were
more consistent with an arm’s-length charge than were
Petitioners’ allocations.
However, Moore’s allocations pertained only to the six
Restaurant Corporations. Moore neither addressed any fees
attributable to the Realty Corporations nor allocated any fees
to Bryan Restaurant, Inc., which was created in 1992.
At trial, Petitioners disputed Moore’s time-based
allocations because Moore never considered special
circumstances that varied the time that Owners dedicated to
particular Group members. Specifically, these special events
include a fire that demolished a Kenco restaurant in 1990, a
scrape and rebuild of a K-K restaurant in 1990, a unique
employment problem in 1990 (i.e., civil rights commission
case filed by former employee), a worker’s compensation
claim in 1990, additions and remodeling of a K-K restaurant
in 1991, land acquisitions and zoning litigation, dramatic
decreases in sales caused by rumors of intentionally tainted
food in 1992, and the development and opening of the new
Bryan restaurant in 1992.
Petitioners also dispute Moore’s time-based allocations
because Moore included hours of modestly compensated,
nonowner employees. Additionally, Petitioners dispute
Moore’s treatment of Owner’s hours as equal to maintenance
workers’ hours. Moreover, Petitioners dispute Moore’s
inclusion of 2,000 hours for Borsani in 1992 because Borsani
worked at BKK for only one month in 1992.

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8 Kenco Restaurants, et al.
v. Commissioner
Nos. 98-2416/
2417/2418/2420
The tax court ruled in favor of the Commissioner and found
that Petitioners failed to prove that the reallocations in the
notice of deficiency, based upon gross sales, were arbitrary,
capricious, or unreasonable. The tax court also sustained the
Commissioner’s imposition of accuracy-related penalties.
II.
We review factual findings of the tax court for clear error
and legal questions de novo. See Hoover v. Commissioner,
102 F.3d 842, 844 (6th Cir. 1996) (citing Conti v.
Commissioner, 39 F.3d 658, 662 (6th Cir. 1994)). We review
mixed questions of law and fact under the “clearly erroneous”
standard. See Eli Lilly & Co. v. Commissioner, 856 F.2d 855,
860-61 (7th Cir. 1988) (citing Standard Office Bldg. Corp. v.
United States, 819 F.2d 1371, 1374 (7th Cir. 1987)). Whether
the Commissioner abused or exceeded his discretion in
determining deficiencies against a taxpayer is a question of
fact. See Spicer Theatre, Inc. v. Commissioner, 346 F.2d 704,
706 (6th Cir. 1965); see also American Terrazzo Strip Co.,
Inc. v. Commissioner, 56 T.C. 961, 971 (1971).
The first issue we address is whether the Commissioner
abandoned the notice of deficiency. Petitioners contend that
the Commissioner abandoned the allocations contained in the
notice of deficiency at trial and instead relied upon Moore’s
reallocations. Also, Petitioners contend that the
Commissioner has to establish the reasonableness of his
adjustments because the burden of proof shifted when he
abandoned the original allocations.
The Commissioner, however, contends that he never
abandoned the notice of deficiency and that the purpose of
Moore’s testimony was merely to provide a reasonable
allocation in the event Petitioners were successful in proving
that the allocations contained in the notice of deficiency were
arbitrary, capricious, or unreasonable.
Under current law, the Commissioner may rely on
alternative theories supported by a different methodology than
Nos. 98-2416/
2417/2418/2420
Kenco Restaurants, et al.
v. Commissioner
9
that used in the notice of deficiency. This reliance does not
necessarily place the burden on the Commissioner or render
the notice of deficiency arbitrary, capricious, or unreasonable.
See Altama Delta Corp. v. Commissioner, 104 T.C. 424, 458
(1995) (citing Sundstrand Corp. v. Commissioner, 96 T.C.
226, 354-355 (1991)).
However, if the Commissioner abandons the notice of
deficiency, then the notice of deficiency is no longer
presumed correct, and all that remains is for Petitioners to
show that the transaction was conducted at arm’s length. See
DHL Corp. v. Commissioner, 76 T.C.M. (CCH) 1122, 1144
(1998).
In the instant case, the tax court found that the
Commissioner had not abandoned the notices of deficiency:
“Although the Moore allocation differs from the amounts
allowed by respondent in the notices of deficiency,
respondent is explicit in stating that he has not
abandoned the notice and, we believe, relies on the
Moore allocation only to prove a reasonable allocation on
the contingency that petitioners succeed in showing the
respondent’s allocation to be arbitrary, capricious, or
unreasonable.”
Kenco Restaurants, Inc. v. Commissioner, 76 T.C.M. (CCH)
512, 517 (1998).
Upon our review of the record, we agree with the tax court
and find that the Commissioner did not abandon the notices
of deficiency. The record does not support that either the
Commissioner or Moore rejected Camper’s method in favor
of the time-based method. Also, as shown below in the
second issue, the Commissioner had no reason to establish an
arm’s-length charge other than as a contingency argument in
case Petitioners overcame the initial presumption.
The second issue we address is whether Petitioners have
shown that the reallocations contained in the notice of

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