t c memo united_states tax_court illinois tool works inc subsidiaries petitioner v commissioner of internal revenue respondent docket no filed date caroline h ngo thomas kevin spencer kathryn c vouri and justin e jesse for petitioner h barton thomas jr justin d scheid mindy y chou and john p healy for respondent memorandum findings_of_fact and opinion lauber judge with respect to petitioner’s federal_income_tax for the internal_revenue_service irs or respondent determined a deficiency of dollar_figure in his answer respondent asserted that petitioner is also liable for an accuracy-related_penalty of dollar_figure under sec_6662 in date the worldwide group headed by illinois tool works inc itw or petitioner had on its balance_sheet about dollar_figure million of cash held most- ly by european affiliates itw desired to bring a portion of this cash back to the united_states to do so it employed a plan that combined intercompany debt with a return-of-capital distribution this repatriation plan worked as follows one of petitioner’s lower-tier controlled_foreign_corporations cfcs lent money to an upper-tier cfc the upper-tier cfc was a holding_company with no current or accumulated_earnings_and_profits e_p the upper-tier cfc then distributed the loan proceeds of dollar_figure to one of petitioner’s domestic subsidiaries which reported the dis- tribution as a nontaxable return_of_capital the irs attacked this strategy on two grounds first it contended that the loan between the cfcs was actually a dividend if that were so the e_p of the lower-tier cfc would move to the upper-tier cfc and the distribution by the up- per-tier cfc would be taxable as a dividend under sec_301 second if 1all statutory references are to the internal_revenue_code in effect for the year at issue and all rule references are to the tax_court rules_of_practice and procedure we round all monetary amounts to the nearest dollar the form of the intercompany loan were respected the irs contended that the domestic parent had insufficient basis in the upper-tier cfc to absorb the distribu- tion as a return_of_capital if that were so a portion of the distribution would be taxable as capital_gain under sec_301 there are four principal issues that we must decide whether the loan from the lower-tier cfc to the upper-tier cfc should be treated as bona_fide debt if we find the loan to be bona_fide debt whether it should nevertheless be re- characterized under one or more judicial anti-tax-avoidance doctrines as a divi- dend to the upper-tier cfc or to petitioner if the loan is not recharacterized as a dividend whether the domestic parent had sufficient basis in the upper-tier cfc to treat the entirety of the distribution as a return_of_capital and whether peti- tioner is liable for an accuracy-related_penalty we resolve all issues in petition- er’s favor findings_of_fact the parties filed stipulations of facts with attached exhibits and stipulations of settled issues all of which are incorporated by this reference itw is a publicly held c_corporation founded in it had its principal office and principal_place_of_business in illinois when it filed its petition a company background and ownership structure itw is the parent of a group of more than companies that manufacture industrial products and equipment petitioner and its domestic subsidiaries have filed consolidated federal_income_tax returns at all relevant times during petitioner’s foreign subsidiaries did business in countries we will refer to these companies collectively as the itw group in the itw group had operating revenue of about dollar_figure billion and net_income of dollar_figure billion it divided its business operations into four segments engineering products north america engineering products internation- al specialty systems north america and speciality systems interna- tional it had about big_number employees in that year between and petitioner pursued a strategy of growth through ac- quisitions to raise cash for these acquisitions and for a dollar_figure million stock buy- back in date petitioner substantially increased its short-term debt its out- standing commercial paper cp obligations which stood at dollar_figure million in date grew to dollar_figure million by date during petitioner was the sole shareholder of itw international hold- ings inc inhold a delaware corporation in date inhold changed its name to itw global investments inc inhold in turn was the sole shareholder of paradym investments ltd paradym which was originally organized in bermuda in date paradym became a domestic_corporation and a member of petitioner’s consolidated_group during paradym was the sole shareholder of cs europe holdings ltd cse a bermuda corporation with its registered office in bermuda petition- er formed cse in as part of a project to place the itw group’s european subsidiaries under several tiers of foreign holding_companies cse situated at the top of this structure is what some commentators have described as a super hold- ing company in cse was the sole shareholder of miller insurance ltd miller a captive_insurance_company and cs australasia holdings ltd csa both ber- muda corporations csa like cse was a holding_company with no active busi- ness operations directly and indirectly csa held stock in about foreign operating companies including the following itw group france illinoi sec_2see alan w granwell news analysis contract manufacturing arrange- ments and subpart_f tax note sec_381 bret wells what corporate inversions teach about international tax reform tax notes int’l 3petitioner formed csa in as part of a restructuring of its australian and asian subsidiaries to achieve among other things australian tax benefits petitioner later contributed csa to cse as part of a separate project designed to achieve among other things u k and u s tax benefits tool works nederland b v itw deutschland gmbh itw italy holding s_r l italy holding and itw belgium s p r l we will refer to these five operating companies collectively as the european borrowers italy holding was the sole shareholder of several italian subsidiaries and disregarded entities including italy finance srl italy finance at all relevant times cse and csa were cfcs within the meaning of sec_957 petitioner inhold and paradym were u s shareholders of these cfcs under sec_951 because they owned directly or indirectly of the total combined voting power of all classes of the cfcs’ stock the parties have stipulated that csa had the following amounts of e_p for its fiscal years ending fye date and fye nov current e_p accumulated e_p dollar_figure big_number dollar_figure big_number in congress enacted a tax_holiday that enabled u s shareholders of cfcs to enjoy a reduced_tax_rate of on dividends received from their for- eign affiliates american_jobs_creation_act_of_2004 pub_l_no sec_422 sec_118 stat pincite5 to take advantage of this tax_holiday petitioner caused csa and other affiliates to pay substantial dividends to cse which in turn paid substantial dividends to paradym during its fye date cse paid paradym dividends of dollar_figure and during its fye date cse paid paradym dividends of dollar_figure petitioner reported all of these dividends on the relevant forms information_return of u s persons with respect to certain foreign_corporations as of date cse had no remaining e_p b cash pool most borrowing by the european members of the itw group was done by holding_companies using bank lines of credit within each country the operating companies would maintain funds in operating accounts any excess positive bal- ance ie amounts above what was needed for current operations would be swept into the holding_company within that country and aggregated with the excess posi- tive balances of the other operating companies when it needed to borrow the holding_company would draw on a line of credit with a local bank and transfer the loan proceeds into that country’s cash pool beginning in the itw group used a notional cash pool operated by bank mendes gans n v bmg a dutch bank in a notional cash pool one 4from through csa paid cse more than dollar_figure billion of divi- dends including the dollar_figure dollar_figure dollar_figure referred to in the text participant called the cash pool header calculates a consolidated net position by offsetting the cash surpluses against the cash deficits of the various participants unlike a zero balance cash pool in which offsets are implemented by actual transfers of cash a notional cash pool involves no physical movement of money between participants’ accounts about members of the itw group participated in the bmg cash pool during csa and cse joined the cash pool in date using the u s dollar as their functional_currency the cash pool was managed by an itw finance officer in the united_states whose duties included approving wire trans- fers and investing funds the cash pool operated as follows an entity depositing money into the cash pool would receive deposit credit on its separate bmg account an entity withdrawing money from the cash pool would show a corresponding debit on its separate bmg account an entity could withdraw more funds from the cash pool than it had deposited provided the overall cash pool balance was positive any cash pool account with a credit balance would receive interest from bmg and any cash pool account with a debit balance would be charged interest by bmg bmg determined interest rates daily by re- ference to market rates for the applicable country’s currency cash pool accounts with credit balances were pledged as security for accounts with debit balances itw provided a dollar_figure million guaranty to be fulfilled in the event one or more participants in the cash pool defaulted bmg offered netting services in connection with this notional cash pool this enabled payments and receipts between participating entities to be offset after calculating the net amount due to or from each participant bmg credited or debited that participant’s cash pool account accordingly c repatriation planning petitioner’s capital solutions group capital solutions was responsible for all tax planning tax_advice and tax compliance during in date capital solutions began planning a repatriation of funds from petitioner’s cfcs to facilitate the retirement of outstanding cp and to fund new acquisitions its first step was to create a schedule titled cash available for repatriation which com- piled excess funds held by cse and its subsidiaries as of date numerous individuals assisted with planning the repatriation including allan sutherland petitioner’s senior vice president who also served as presi- dent and a director of cse and csa lisa hampton manager of strategic tax planning and project manager for the repatriation transaction felix l rodri- guez jr petitioner’s treasurer who also served as vice president and a director of cse and csa and ronald kropp petitioner’s senior vice president and chief financial officer at all relevant times mr sutherland and mr rodriguez signed documents on behalf of csa and cse in their capacities as directors on date ms hampton informed mr sutherland that the euro- pean affiliates had substantial positive balances in the bmg cash pool that could be used to fund part of a repatriation from cse petitioner also considered having cse borrow from third-party banks or capital markets to fund the repatriation but in a follow-up email on date ms hampton informed mr suth- erland that cse did not have audited financial statements which would have been necessary for a bank borrowing unless petitioner agreed to guarantee the loan be- cause petitioner did not wish to guarantee such a large loan and because there was insufficient time before the end of the year to secure audited financials mr suth- erland decided that the best course of action was for cse to secure an intercom- pany loan petitioner desired to complete the repatriation before year-end in order to pay down its outstanding cp on date mr sutherland and ms hampton discussed the terms for a loan from csa to cse after considering prevailing market rates for similar intercompany debt they decided upon as the appropriate interest rate and five years as the appropriate term in selecting these loan terms they also compared the cost of intercompany borrowing by the cfcs with interest rates on short-term cp borrowing by petitioner lending funds to cse would require csa temporarily to go negative in the cash pool and pay interest on its debit balance pincite sometime in early date ms hampton prepared a plan for exe- cuting the repatriation which was summarized in a tax planning project approval form tppaf this document noted that petitioner had been borrowing on short term cp to fund its domestic acquisitions and that the european subsidiaries had excess cash it explained that petitioner would cause certain of its foreign subsidiaries to borrow from their local banks deposit the proceeds into the bmg cash pool and have csa borrow from the pool to fund a loan to cse which would distribute the loan proceeds to paradym the tppaf noted that for us tax purposes the distribution is being treated as return_of_capital and is not taxable the tppaf projected that the proposed repatriation strategy would yield tax sav- ings of about dollar_figure million for the itw group mr kropp presented the tppaf to petitioner’s board_of directors on de- cember he explained that combining an intercompany loan to cse with a distribution of the loan proceeds as a return_of_capital would be the most tax-effi- cient method of repatriating funds mr kropp also presented a proposal to in- crease guarantees for european borrowings in connection with the repatriation the board approved the tppaf and mr kropp’s proposal d repatriation transactions petitioner’s repatriation plan proceeded as follows between november and december italy holding and its subsidiaries executed a series of transactions designed to enable them to lend to the other euro- pean borrowers while maintaining their ability to deduct interest on indebtedness under italy’s recently enacted thin_capitalization rules these transactions cul- minated in a dollar_figure million loan from italy finance to a european affiliate which bmg deducted from italy holding’s cash pool account and credited to cse’s cash pool account between december and the european borrowers secured from local banks loans of dollar_figure million of which dollar_figure million was from new short-term credit facilities and dollar_figure million was from existing facilities petitioner guaranteed the borrowing for the new credit facilities between december and the european borrowers deposited the loan proceeds described above into the bmg cash pool they concurrently liqui- 5this loan which had a five-year term was later extended twice the loan was repaid in full with interest on date dated dollar_figure million of money market funds and deposited the proceeds into the bmg cash pool on december mr sutherland and mr rodriguez acting in their capa- cities as officers and directors of cse and csa authorized cse to borrow dollar_figure from csa this loan was documented in a one-page promissory note that provided for simple interest and a five-year repayment term note no principal payments were due until maturity and there was no premium or penalty for early repayment the note stipulated that csa could enforce pay- ment of principal and interest made no provision for subordinating the debt to cse’s other obligations and stated that delaware law would govern its interpreta- tion csa recorded this note on its books as an intercompany note receivable and cse recorded it as an intercompany note payable mr sutherland and mr rodriguez concurrently authorized the distribu- tion of the dollar_figure loan proceeds from cse to paradym to avoid multiple currency conversions they directed cse to transfer this amount directly to inhold paradym’s parent on december the euro equivalent of dollar_figure was transferred from csa’s cash pool account at bmg to cse’s cash pool account this caused csa temporarily to have a negative cash pool balance of dollar_figure which accrued interest pincite annually later that day bmg transferred dollar_figure from cse’s cash pool ac- count to inhold’s bank account in the united_states petitioner used these funds to pay down its outstanding cp balance which was reduced from approximately dollar_figure million on december to about dollar_figure million on december e repayment of the cse note during petitioner considered a variety of options for repaying the cse note including third-party borrowing intercompany borrowing and the issuance of capital market debt or equity instruments in late the irs began examining petitioner’s and tax returns focusing chiefly on the repa- triation transaction and petitioner subsequently filed a protest with the irs ap- peals office in date when the cse note was due to mature petition- er’s case was still pending with the appeals_office petitioner believed that it would be inadvisable to repay the cse note while the appeals_office was considering its tax_liability petitioner accordingly decided that csa and cse should extend for one year the maturity of the existing loan on date cse executed a new one-year promissory note for dollar_figure the outstanding principal balance of the note the note provided that cse would pay interest at the 90-day libor rate plus basis points to be reset quarterly like the note the note made no provision for subordinating the debt to cse’s other obligations it stipu- lated that principal and interest were due at maturity that there was no premium or penalty for early repayment and that csa could enforce payment of principal and interest the new loan was recorded on the books of both companies as an inter- company note for dollar_figure in date cse borrowed dollar_figure million from miller and received a divi- dend of dollar_figure million from it in date cse used this dollar_figure million to re- pay part of the principal on the note reducing the outstanding balance to dollar_figure as of date the irs appeals_office had not concluded its review of the repatriation transaction and petitioner decided upon another one- year extension of the maturity_date on date csa and cse executed a new one-year promissory note for dollar_figure the terms of note were identical to those of the 6libor london interbank offering rate is an average interest rate that major international banks charge each other for large loans it is considered one of the primary benchmarks for short-term interest rates worldwide and it was the short-term rate at which petitioner itself could borrow using libor as a baseline rate petitioner added basis points to account for cse’s position as a subsidiary within the itw group note except that the interest rate was set pincite-day libor plu sec_50 basis points to be reset quarterly csa and cse recorded the new loan on their books as an intercompany note for dollar_figure during petitioner divested itself of certain businesses generating substantial cash that could be used to reduce debt on date in- hold’s board authorized the contribution of dollar_figure to paradym which made through a subsidiary a capital_contribution of the same amount to cse that same day cse paid dollar_figure to csa representing full payment of the principal balance on the note plus accrued interest for after making this payment cse had a debit balance in the bmg cash pool of dollar_figure the and notes did not mandate periodic interest payments permitting both principal and interest to be paid at maturity however cse and csa reported annually on their books the payment and receipt of interest in the following amounts 7interest on the and notes was keyed to the 90-day libor rate which stayed below during those years see david hou david skeie fed reserve bank of n y staff report no libor origins economics crisis scandal and reform thus the interest cse paid during and was substantially less than the interest it paid on the note which bore simple interest of fiscal_year amount dollar_figure big_number big_number big_number big_number short_year big_number big_number short_year big_number short_year big_number big_number on the dates on which cse reported payment of this interest it had before paying the interest a debit balance in the bmg cash pool or a credit balance smaller than the amount of interest_paid as follows date cse cash pool balance dollar_figure big_number big_number big_number big_number big_number big_number besides the cse loan petitioner’s books on date showed other outstanding intercompany debts with an aggregate face_amount of dollar_figure billion in response to respondent’s discovery requests petitioner provided information for a representative sample of intercompany loans of these loans were fully repaid or settled via intercompany transfer remained outstanding were extinguished upon merger of the lender and borrower and was divested when petitioner sold both entities to a third party f financial and tax reporting at all relevant times petitioner and its domestic subsidiaries including in- hold and paradym used the calendar_year for tax and financial reporting purposes during most of petitioner’s foreign subsidiaries reported using an fye november petitioner filed forms as required for all tax years reporting each cfc’s balance_sheet income and expenses and transactions with related en- tities petitioner reported all relevant information about the repatriation on its return because csa and cse used an fye november information regarding the date repatriation was reported on their forms for fye date to prepare its consolidated financial statements petitioner used hyperion an accounting software program and then mapped these accounts into corptax 8using an fye november allowed petitioner’s accounting personnel to close out the foreign subsidiaries’ books before the end of petitioner’s taxable_year which made it easier to produce consolidated financial statements its tax_accounting software mapping the accounts involved a two-step process by which the trial balances were first reviewed for accuracy and then linked to specified accounts in corptax the cse note was reported in petitioner’s hyperion trial balance for as a dollar_figure intercompany note payable to csa cse’s form_5471 for fye date shows on line of schedule f current liabilities of dollar_figure which includes its indebtedness to csa the interest payment on the note is reflected in the hyperion trial balance on line i-43 intercompany interest and the detail indicates that this interest was paid to csa cse’s form_5471 for fye date shows the interest payment on line of sched- ule c income statement petitioner used a similar process to report the promis- sory notes and interest payments on csa’s books and forms for fye no- vember and subsequent years g irs examination petitioner timely filed form_1120 u s_corporation income_tax return for it attached to its form_1120 pro forma returns for inhold and paradym neither of these pro forma returns reported as income the dollar_figure distribu- tion from cse because petitioner treated it as a return_of_capital to paradym the irs selected petitioner’s return for examination and determined that the date repatriation was taxable the irs first determined that the trans- fer from csa to cse was a dividend rather than a loan that e_p of dollar_figure had thus tiered up to cse and that cse’s distribution to paradym was therefore taxable as a dividend under sec_301 and sec_316 alternatively the irs de- termined that petitioner had failed to substantiate paradym’s basis in cse so that the distribution if not a dividend was not a tax-free return_of_capital under sec_301 but rather was taxable capital_gain under sec_301 the irs issued a timely notice_of_deficiency setting forth these adjustments and petitioner timely petitioned this court for redetermination in his answer re- spondent asserted an accuracy-related_penalty under sec_6662 in an amended answer respondent attacked the repatriation transaction on two alter- native theories that the loan from csa to cse should be recharacterized as a dividend under judicial anti-tax-avoidance doctrines and that the transaction was in substance a loan from csa directly to petitioner or paradym generating a taxable investment in u s property under sec_956 and c h expert testimony9 robert c grien respondent offered and the court recognized robert c grien as an expert in debt capital markets he evaluated the terms of the note and opined that it would not have been salable to a third party without substantial modifications he pointed out that the note did not contain restrictive covenants typically found in publicly issued investment-grade debt instruments such as restrictions on invest- ment activities restrictions on payment of dividends and negative pledges of as- sets for that reason he opined that a third party would have been unwilling to extend credit to cse on the terms set forth in the note mr grien also observed that the note was not guaranteed by pe- titioner did not explicitly mandate periodic_payment of interest and was in his view structurally subordinated to debts of csa’s operating subsidiaries mr grien opined that the note to be marketable to an independent investor would need to include at a minimum provisions mandating interest payments at fixed times acceleration of principal upon default or bankruptcy and a restriction 9an alphabetical listing of petitioner’s and respondent’s expert witnesses together with a short résumé of each appears in the appendix beginning infra p against mergers while noting the absence of truly comparable companies he opined that cse’s credit rating would be at most bbb r glenn hubbard respondent offered and the court recognized r glenn hubbard as an expert in corporate finance and economics evaluating the economic reality of the repatriation transaction he opined that it lacked a valid business_purpose spe- cifically he concluded that there was no business reason for csa to lend money to cse to enable it to make a distribution to paradym dr hubbard also opined that cse lacked an independent ability to repay csa from an economic perspective he believed funds for repayment could only come from csa itself via distributions to cse or from petitioner or its domestic subsidiaries none of which had guaranteed the note and he observed that cse made its interest payments to csa by borrowing money from the bmg cash pool which in his view represented a circular flow of funds saul froomkin petitioner offered and the court recognized saul froomkin as an expert in bermuda commercial law he opined that the note was enforceable under bermuda law that csa’s directors would violate their fiduciary duties under ber- muda law if they sought to prevent csa from enforcing repayment of the note and that mr sutherland and mr rodriguez as directors of csa would be personally liable to it if they did not enforce repayment of the note he also opined that cse’s obligation to repay csa was not subordinated to cse’s obligations to third-party creditors israel shaked petitioner offered and the court recognized israel shaked as an expert in corporate finance dr shaked considered whether cse could have obtained fi- nancing from a third party in his expert report he performed three analyses a debt service analysis which considers whether a borrower has sufficient cashflow to make future principal and interest payments an equity cushion analysis which considers the amount by which the value of the borrower’s assets exceeds its indebtedness and a capital adequacy analysis which considers the borrow- er’s leverage compared to industry benchmarks applying these analyses dr shaked concluded that cse and its subsidiar- ies would have been expected to generate sufficient cash between to make payments on all of their outstanding debts when they became due he speci- fically found that cse was projected to have free cashflow of about dollar_figure bil- lion during more than enough to discharge all its debts cse would not require additional debt financing to repay the csa loan and cse’s equity cushion was at least dollar_figure billiondollar_figure he concluded that cse was adequately capitalized and had substantial unused debt capacitydollar_figure and whereas cse’s peer companies had debt-to-equity ratios between and dr shaked calculated that cse’s debt-to-equity_ratio ranged between and dollar_figure in a rebuttal report he concluded that dr hubbard had erred in opining that cse lacked an independent ability to repay the loan and that csa in effect had created a liability to itself on the theory that its funds were a likely source of repayment william chambers petitioner offered and the court recognized william chambers as an ex- pert in assignment of credit ratings in his report dr chambers stated that he would likely have assigned cse each time it executed a note in favor of csa an investment grade rating of at least bbb under the standard and poor’s s p credit rating system he based this conclusion on cse’s strong cashflow and low debt levels debt represented only of cse’s capital structure before the 10dr shaked found that for the year in which the note matured the cse group had an equity cushion of about dollar_figure billion 11as of date the assets of cse and its subsidiaries exceeded their liabilities by approximately dollar_figure billion 12the debt-to-capital ratio was when the note was issued and in when it matured note was issued and peaked at only of capital in dr chambers further opined that cse had at least a satisfactory business risk profile in cse’s profit margins were relatively steady in and subsequently and although cse’s debt was structurally subordinated this fact was irrelevant because csa had very little outstanding debt csa’s consolidated indebtedness peaked at dollar_figure million in and decreased to dollar_figure million in charles chigas petitioner offered and the court recognized charles chigas as an expert in debt capital markets in his report mr chigas opined that a third-party investor would have purchased the note on substantially_similar terms he based his opinion on the following conclusions cse’s strong credit profile supported an s p credit rating of at least bbb the financial terms of the note were substantially_similar to standard investment grade terms and cse’s ratio of debt to ebitda earnings before interest taxes depreciation and amortization was extremely low mr chigas observed that the note lacked restrictive nonfinancial covenants but opined that this was typical of investment grade debt while acknowledging that cse’s ability to defer interest payments until maturity was atypical of invest- ment grade debt he opined that an upward adjustment of to basis points would be sufficient to account for that fact finally mr chigas noted that the corporate bond market was extremely strong in which would have made cse’s loan attractive to investorsdollar_figure opinion i burden_of_proof the irs’ determinations in a notice_of_deficiency are generally presumed correct and the taxpayer bears the burden of proving them erroneous rule a 290_us_111 respondent generally bears the burden_of_proof in respect of any new_matter increases in deficiency and affirmative defenses pleaded in the answer or in an amended answer rule a because we decide all factual issues on a preponderance of the evi- dence we need not decide who has the burden_of_proof see sec_7491 138_tc_306 13petitioner also offered as an expert witness todd miller who prepared a study to calculate paradym’s basis in cse we have decided to treat mr miller as a summary witness rather than an expert witness see infra pp ii cse note a bona_fide debt petitioner contends that the loan from csa to cse constituted bona_fide debt that was used to fund a tax-free return-of-capital distribution from cse to paradym respondent contends that the loan was not bona_fide debt that the funds transferred from csa to cse constituted a disguised_dividend that cse was required to increase its e_p under sec_312 by the amount of this dividend and that the subsequent distribution from cse to paradym was a taxable dividend under sec_316 and sec_301 whether an advance of funds is treated as genuine debt must be considered in the context of the overall transaction 827_f2d_1409 9th cir our inquiry typically focuses on whether the taxpayer intended to create a debt with a reasonable expectation of repayment and if so whether that intent comports with creating a debtor-creditor relationship 61_tc_367 the key to this deter- mination is the taxpayer’s actual intent 748_f2d_1365 9th cir rev’g tcmemo_1983_120 a r lantz co v united st424_f2d_1330 9th cir absent stipulation to the contrary appeal of this case would lie to the u s court_of_appeals for the seventh circuit that court has held that w hether withdrawals by a shareholder from a corporation are treated for tax purposes as loans or dividends turns on whether at the time of the withdrawals the taxpayer intended to repay them 728_f2d_945 7th cir aff’g tcmemo_1983_98 in determining whether the taxpayer intended to repay the withdrawals the seventh circuit considers objective factors as in- dicative of intent but regards no single factor as dispositive ibid see also frier- dich v commissioner 925_f2d_180 7th cir aff’g tcmemo_1989_393 this determination is purely a question of fact busch f 2d pincite o nce the taxpayer’s intent is found that finding is conclusive of the legal issue of loans versus dividends ibid we will apply the factors the seventh circuit mentioned in busch we will supplement that analysis with discussion of factors listed in 74_tc_476 to the extent the seventh circuit has sug- gested by citing opinions from this court or other courts that such additional factors merit discussion in applying these factors we recognize as the seventh circuit recognized in busch f 2d pincite that there can be especially strong support for finding corporate advances to be dividends where the purported bor- rower is the sole shareholder of the purported lender this sole-shareholder scenario creates obvious difficulties to thinking of the shareholder and corporation as debtor and creditor ibid quoting 611_f2d_866 ct_cl see also 232_f2d_118 2d cir noting that an arrangement is subject_to close scrutiny by the commissioner where it is made between a parent_corporation and its wholly-owned subsidiary rev’g 21_tc_513 we will consider in our analysis the following factors from busch the taxpayer’s statement of intent to repay the extent of the shareholder’s control of the corporation the retained earnings and dividend history of the corpora- tion the size of the transfer the presence of conventional indicia of debt such as a promissory note collateral and interest charges the treatment of ad- vances in corporate records the history of repayment and the taxpayer’s use of the funds we will also consider the following factors from dixie dairies participation in management as a result of advancing funds the status of the advances in relation to regular corporate creditors thinness of the capi- tal structure the risk involved in making the advances the identity of interest between the creditor and the shareholder and the ability to obtain loans from outside sources dixie dairies t c pincite see 398_f2d_694 3d cir noting that an advance may not be a bona_fide loan if an outside lender would not have advanced funds on the same terms as did the corporate insider am offshore inc v commissioner 97_tc_579 shaw v commissioner tcmemo_2013_170 106_tcm_54 noting that in determining whether an advance of funds constitutes bona_fide debt economic reality provides the touchstone aff’d 623_fedappx_467 9th cir stated intent to repay when analyzing intent we consider the parties’ actual intent at the time the advances were made see busch f 2d pincite a r lantz co f 2d pincite 284_f2d_928 7th cir aff’g tcmemo_1959_225 our aim is to determine whether the parties intended to create a definite obligation repayable in any event see hewlett-packard co v com- missioner tcmemo_2012_135 103_tcm_1736 aff’d 875_f3d_494 9th cir intent is a factual issue that we decide on the basis of all the circumstances see busch f 2d pincite 532_f2d_1204 8th cir petitioner’s actions strongly suggest that it intended to create a bona_fide debt the note evidencing the original advance and the and notes evidencing the refinanced advances were legally binding documents each loan document was reviewed and approved by csa’s and cse’s board_of directors before it was executed the notes required_payment of interest and repayment of principal at fixed maturity dates each year cse made interest payments which were properly recorded on its and csa’s books cse repaid the loan in full via cash transfers in and dollar_figure although it may be challenging to prove intent to repay when the borrower is the sole shareholder of the lender busch f 2d pincite the itw group has a good track record in this respect at year-end itw had on its book sec_122 oth- er intercompany loans with an aggregate face_amount of dollar_figure billion during dis- covery petitioner provided information for a representative sample of such loans of those were fully repaid were discharged in a merger or acquisition and remained outstanding petitioner’s current and former employees credibly testified that itw always followed a live by the agreement principle for repay- ing debt including intercompany debt this pattern suggests to us that petitioner regarded its intercompany loans as bona_fide debts that were intended to be repaid and were in fact repaid 14although respondent contends that petitioner failed properly to record the advance csa recorded an asset and cse recorded a liability in the amount of the loan in their corporate records and on their forms see supra p respondent contends that petitioner’s refinancing of the loan weighs against a finding of genuine indebtedness we disagree cse clearly had the financial capacity to repay the loan at the original maturity_date in date be- cause this case was then pending before irs appeals petitioner believed it advis- able to extend the maturity_date on these facts we find that refinancing the loan casts no doubt on cse’s intent to repay see litton bus sys inc t c pincite n we do not consider as particularly detrimental to petitioner’s case the fact that payments of principal and interest were suspended when the internal_revenue_service challenged the propriety of the debt 53_tc_451 refinancing is an accepted busi- ness practice and we see nothing wrong with it if reasonable in the context of the particular facts respondent contends that cse could have funded its distribution to para- dym in other ways eg by going negative in the bmg cash pool or by borrow- ing in the credit markets we do not see the logic of this argument the fact that cse might have secured other loans sheds no light on its intent to repay the loan it actually secured the relevant question is whether at the time csa advanced funds cse intended to repay that debt in full because we find that cse did evi- dence its intent to repay the debt the first busch factor favors petitioner extent of shareholder control dividend treatment may be indicated where a shareholder has complete control_over the corporate accounts so that he has no fear that the corporation would demand repayment see busch f 2d pincite cse was the sole share- holder of csa at all relevant times we accordingly find that the second busch factor favors respondent although this factor favors dividend treatment we find that it carries some- what less weight here in the busch case the sole shareholder was an individual who extracted cash from his corporation and used that cash for his personal pur- poses itw is a publicly traded company that like many of its peers had a sub- stantial amount of intercompany debt on its consolidated financial statements in any multinational group such as this the borrowing and lending entities will typi- cally be related through common ownership by the ultimate parent notwithstanding this common ownership the record establishes that cse and csa took all steps required to create genuine indebtedness the promissory notes were legally binding documents like the borrowers in the other inter- company loans on itw’s books cse was required to fulfill its obligations to its creditors as mr froomkin testified csa’s directors mr sutherland and mr rodriguez had a fiduciary duty to demand repayment from cse if they breached those duties they would subject themselves to legal repercussions under bermuda and u s law for these reasons we find that the second busch factor while favoring respondent weighs somewhat less heavily in the balance retained earnings and dividend history if a corporation has substantial earnings over many years but pays no divi- dends recurring loans to a shareholder may suggest dividend treatment see busch f 2d pincite on the other hand where a company pays regular divi- dends and adheres to formal requirements for both dividends and debt loans to shareholders may properly be treated as debt where the advances are intended as such see eg 129_f2d_512 5th cir csa advanced funds to cse in date during the four preceding years and the six subsequent years csa paid cse in the aggregate more than dollar_figure billion of dividends the parties have stipulated that these dividends were record- ed on both companies’ books and forms for all years csa thus had a sub- stantial dividend-paying history respondent notes that csa did not pay any dividends to cse during in particular but we decline to draw a negative inference from this many corpor- ations do not pay dividends in every year of their existence the seventh circuit has directed us to consider the dividend history of the corporation busch f 2d pincite we find that csa’s payment of dollar_figure billion of dividends during the years surrounding the year of the loan favors treating that advance as debt size of the advance this factor overlaps with the ability to repay factor as dr shaked cred- ibly testified the dollar_figure loan was not particularly large relative to cse’s equity cushion of dollar_figure billion cse had ample cashflow from which to repay the loan see infra pp we accordingly find that the fourth factor is neutral or favors petitioner slightly conventional indicia of debt in applying this factor we consider whether there exist formal indicia of debt such as a promissory note interest payments a fixed maturity_date and a right to enforce repayment because csa and cse strictly adhered to all loan formalities this fifth factor favors petitioner the issuance of a bond debenture or promissory note is generally required to establish the existence of bona_fide indebtedness see hardman f 2d pincite compliance with such formalities may be accorded less weight when the parties are related see fin hay realty co f 2d pincite 95_tc_257 but the note evidencing the cse loan was a legally binding debt_instrument and to that extent it supports debt treatment both the original note and the two successor notes required_payment of interest at specified rates upon maturity of the loan cse in fact paid all re- quired interest on an annual basis cse and csa recorded these payments on their books as interest on intercompany indebtedness both the original note and the two successor notes specified definite dates for repayment of principal the presence of a fixed maturity_date indicates a fixed obligation to repay a characteristic of a debt obligation 464_f2d_394 5th cir see 55_tc_345 a definite maturity_date on which the principal falls due for payment without reservation or condition is a fundamental characteristic of a debt the right to enforce the payment of interest is one of the requisites of a genuine indebtedness 34_tc_829 aff’d 290_f2d_870 2d cir the right to enforce payment of prin- cipal upon maturity of the loan is likewise characteristic of true debt laidlaw transp inc v commissioner tcmemo_1998_232 75_tcm_2598 see kraft foods co f 2d pincite noting that an unconditional obliga- tion to pay interest and principal are necessary features of instruments of indebtedness mr froomkin credibly testified that cse’s promissory notes to csa were binding obligations under bermuda law and that bermuda law provided mech- anisms by which csa could enforce payment he testified that csa’s and cse’s directors had separate fiduciary duties to each entity that required them to act in each entity’s best interest this suggests that csa would exercise its right to en- force payment of interest and principal on the notes respondent contends that csa had no practical ability to enforce repayment because cse had no operating_assets but companies often borrow against capital assets including stock of their subsidiaries as an intermediate holding_company cse borrowed against the value represented by the stock of csa and its numerous subsidiary operating companies respondent’s argument confuses the obligation to repay with the source of funds to be used for repayment like any holding_company borrower cse had three possible sources of funds for repayment of the loan earnings from lower- tier operating subsidiaries capital contributions from its parent or a third-party refinancing the evidence established that csa had the legal ability to enforce repayment under bermuda law how cse might choose to fund the repayment is a wholly separate question we conclude that the cse loan bore all conventional indicia of debt including the creditor’s ability to enforce payment of interest and principal the fifth busch factor thus favors petitioner treatment of advances in corporate records respondent agrees that csa and cse recorded the loan as debt on their books that cse reported the loan as a liability on its forms and that both parties generally treated the note as debt on their financial records although the loan was shown as a liability on cse’s form_5471 and as an asset on csa’s form_5471 in neither case was it labeled a loan to or from shareholders this minor discrepancy does not support an inference that the note was a disguised_dividend see alterman foods inc f 2d pincite emphasizing that the ad- vance in question was recorded as an asset on the subsidiary-lender’s books and as a liability on the parent-borrower’s books respondent contends that petitioner did not adequately document the plan for repayment of the loan in date when cse borrowed the funds we know of no requirement that a borrower do this when a homeowner takes out a mortgage loan with a five-year balloon he may have no concrete plan for repaying the loan five years later he may liquidate other assets to pay off the loan he may refinance it or he may sell the house for present purposes the relevant question is whether the dollar_figure loan was consistently treated as debt on csa’s and cse’s books because it was this sixth factor favors debt treatment repayment history and source a borrower’s ability to repay principal and interest out of projected cash- flow supports debt characterization see na gen p’ship subs v commis- sioner tcmemo_2012_172 103_tcm_1916 characterizing ad- vance from parent to subsidiary as debt where subsidiary had sufficient cashflow to make all payments a borrower’s timely payment of interest and principal consistently with the terms of the underlying instrument likewise supports debt treatment see pepsico puerto rico inc v commissioner tcmemo_2012_ 104_tcm_322 cse’s cashflow could easily satisfy its debt obligations as a holding com- pany cse’s projected cashflow consisted principally of earnings expected to be generated by its lower-tier operating subsidiaries dr shaked testified that these subsidiaries were expected to generate during at least dollar_figure billion of free cash and the record supports his testimony he concluded and we agree that cse had potential debt capacity of at least dollar_figure billion thus it could easily have secured third-party refinancing for the dollar_figure loan if operating earn- ings ever fell short cse in fact made annual interest payments on the loan the principal was originally due to be repaid in date but petitioner refinanced the loan twice while the irs was auditing its return as noted earlier we do not think this refinancing casts any doubt on the transaction’s debt status cse repaid dollar_figure million of principal in late and repaid the remaining principal balance in full together with accrued interest for in date when making interest payments before maturity cse initially borrowed funds from the bmg cash pool it later repaid those borrowings by depositing into the bmg cash pool dividends_paid by the lower-tier operating companies while acknowledging that cse paid interest to csa respondent contends that these payments were circular because they were ultimately funded by dividends from csa’s subsidiaries we do not find this argument persuasive as a holding_company cse’s projected cashflow would necessarily be expected to derive chiefly from the earn- ings of its lower-tier operating subsidiaries respondent appears to contend that a payment of interest should be respected as such only if it is funded by earnings from the debtor’s own operations this theory if accepted would appear to make a holding_company incapable of incurring genuine intercompany debt we are aware of no legal support for that theory cf 23_tc_288 respecting advance to sole shareholder as bona_fide debt where shareholder pledged stock as security for loan and received a dividend to repay part of loan balance na gen p’ship subs t c m cch pincite respecting interest payments where debtor obtained a loan from a third party that was repaid with dividends from debtor’s subsidiary in a related vein respondent contends that cse lacked an independent ability to repay the loan because the source of funds for repayment would have to come from cse’s lower-tier operating subsidiaries itw or a third-party borrow- ing but this will always be true for an intermediate holding_company and it does not mean that cse lacked an ability to repay the loan as drs shaked and cham- bers explained any potential creditor would evaluate cse’s creditworthiness by taking into account the assets and future cashflows of its operating subsidiariesdollar_figure on the basis of these financial facts petitioner’s experts concluded that cse would likely receive an s p credit rating of bbb or bbb both of which are investment grade with projected free cash of at least dollar_figure billion from subsidi- aries during and potential debt capacity of at least dollar_figure billion cse plainly had the ability to repay the dollar_figure loan it actually paid all interest 15any potential creditor would also take into account the likelihood of sup- port from itw cse’s highly profitable ultimate parent as dr chambers stated in his expert report and principal due on that loan we find that the seventh factor favors debt treatmentdollar_figure use of advanced funds in busch f 2d pincite the seventh circuit affirmed this court’s holding that advances of corporate funds to a sole shareholder an individual were constructive dividends where the individual used those advances largely for purely personal purposes how funds are used may also be relevant in deter- mining whether a particular investment constitutes debt or equity where a cor- poration uses a shareholder advance to acquire capital assets the advance is more likely to be characterized as equity estate of mixon f 2d pincite where such advances are used to meet the corporation’s daily operating needs debt treatment may be indicated stinnett’s pontiac serv inc v commissioner 16respondent contends that csa had an implied liability to fund repay- ment of the loan because cse as a holding_company had no significant operating_assets in respondent’s view this created an off-the-books liability on csa’s part that precisely offset the asset represented by the cse note supposedly rendering the loan transaction circular but csa did not in fact have any liability implied or otherwise to fund cse’s repayment of the loan cse could have repaid the loan in at least two other ways by receiving a capital_contribution from itw as it in fact did or by refinancing the loan with a third-party borrowing again the upshot of respondent’s argument is that an intermediate holding_company cannot incur genuine intercompany indebtedness we find no support in law or logic for that theory f 2d 11th cir aff’g tcmemo_1982_314 511_f2d_185 6th cir estate of mixon f 2d pincite cse used the dollar_figure loan proceeds to make a return-of-capital distri- bution to paradym and those funds were ultimately used to pay down petitioner’s cp balance respondent contends that this scenario is at odds with debt treatment because the loan proceeds were not used in cse’s business he analogizes this case to cases in which purported loan proceeds were used for the shareholder’s individual purposes see busch f 2d pincite bergersen v commissioner tcmemo_1995_424 70_tcm_568 finding advance used for con- struction of shareholder’s residence to be a dividend aff’d 109_f3d_56 1st cir it is not clear how the use of funds factor should be evaluated here the shareholder-debtor in this case is a corporation not an individual and corpora- tions do not have personal purposes nor is this a debt equity case one might say that the immediate use of the lent funds--to make a corporate distribution--has the feel of a dividend but the ultimate use of the lent funds--to repay short-term cp indebtedness--may suggest a back-to-back_loan driven by operational business necessities on balance we conclude that this eighth factor is best regarded as neutral and in any event is not entitled to great weight participation in management this factor may be relevant in determining whether a taxpayer’s advance to a corporation constitutes debt or equity if the advance entitles the taxpayer to participate in or to a greater participation in management of the company the ad- vance is more likely to be treated as equity see eg am offshore inc t c pincite but this is not a debt equity case and the advance here was made to the shareholder not by the shareholder csa’s advance could not entitle it to partici- pate in the management of cse its parent_corporation we accordingly find this factor unhelpful here status of advances relative to other debt if a corporation advances funds to a shareholder and if the corporation’s right to repayment is subordinated to claims of the shareholder’s other creditors the argument may be weaker for characterizing the advance as true debt see eg estate of mixon f 2d pincite cma consol inc v commissioner tcmemo_2005_16 89_tcm_701 neither the note nor the and notes subordinated csa’s right to repayment to the rights of cse’s other creditors nor as mr froomkin testified would bermuda law require subordination by reason of csa’s being wholly owned by cse respondent notes that csa’s right to repayment was structurally subordi- nated to any debt including trade debt of csa’s operating subsidiaries with holding_companies however any debt issued is necessarily subordinated to the creditors of its operating company na gen p’ship subs t c m cch pincite since this type of subordination arises automatically it has little rele- vance in assessing whether the parties intended to create genuine indebtedness that cse would repay see ibid noting that structural subordination in these circum- stances is to be expected and does not in and of itself cast doubt on the legitimacy of debt issued by a holding_company structural subordination would be rele- vant not in assessing cse’s intent to repay the loan but in determining whether the creditors of csa’s operating subsidiaries would stand first in line to access the subsidiaries’ assets if the assets were sought to be used as a source of repayment in any event as dr chambers and mr chigas noted csa and its operating subsidiaries had very low debt levels during the relevant period csa’s consoli- dated indebtedness peaked at dollar_figure million in and decreased to dollar_figure mil- lion in given that the operating subsidiaries had projected free cashflows of at least dollar_figure billion during structural subordination would not mean- ingfully impact the likelihood of csa’s getting repaid we find that this factor supports debt characterization adequacy of capitalization the purpose of examining the borrower’s debt-to-equity_ratio is to deter- mine whether it is so thinly capitalized as to make questionable its ability to repay cma consol inc t c m cch pincite if a corporation is too thinly capital- ized a purported loan may be recharacterized as a dividend or as an equity invest- ment see eg 862_f2d_112 7th cir bauer f 2d pincite 125_tc_72 aff’d in part vacated in part and remanded on other grounds 230_fedappx_526 6th cir cse was strongly capitalized between and dr shaked noted that as of date the assets of cse and its subsidiaries exceeded their total liabilities by roughly dollar_figure billion cse’s debt-to-capital ratio taking the csa loan into account was at that time this ratio which was lower than the debt-to-capital ratios of all but one of the companies that dr shaked regarded as cse’s peers indicates very robust capitalization dr shaked reached the same conclusion about cse’s capital structure in when the five-year note matur- ed at that point the cse group had an equity cushion of about dollar_figure billion and a debt-to-capital ratio of around because cse was very far from thinly capitalized this factor supports debt treatment risk involved in making advances in applying this factor we consider whether the funds were advanced with reasonable expectations of repayment regardless of the success of the venture or were placed at the risk of the business 248_f2d_399 2d cir remanding tcmemo_1956_137 if funds are advanced for a risky purpose an inference may arise that the parties did not contemplate repay- ment in all events and hence that the advance should not be treated as genuine debt see pepsico puerto rico inc t c m cch pincite this factor overlaps the thin_capitalization factor which also addresses the risk that an advance will not be repaid in both cases the same facts show that the risk here was quite low far from being devoted to a risky or speculative pur- pose the cse loan proceeds were ultimately used to repay petitioner’s outstanding cp balance by eliminating short-term commercial debt and replacing it with five- year intercompany debt the transaction ultimately reduced the risk profile of the itw worldwide group this factor supports debt treatment identity of interest between creditor and shareholder if shareholders advance funds to their corporation ratably to their percent- age ownership interests an inference arises that the advances may be capital con- tributions rather than loans estate of mixon f 2d pincite monon r r t c pincite this factor has little meaning here because this is not a debt equity case the advances were made to the shareholder not by the shareholder as noted earlier the fact that cse was csa’s sole shareholder somewhat favors respond- ent given the extent of shareholder control see supra pp but we regard the identity of interest factor as essentially neutral here ability to obtain outside loans in applying this factor we consider whether the purported borrower’s finan- cial condition was such that a third-party lender would have lent funds on substan- tially the same terms as did the related_party see 154_f3d_61 3d cir rev’g in part vacating in part tcmemo_1996_ a borrower’s ability to secure a third-party loan to refinance the related- party loan similarly supports debt characterization see na gen p’ship subs t c m cch pincite nestlé holdings inc v commissioner tcmemo_1995_441 70_tcm_682 vacated and remanded on another issue 152_f3d_83 2d cir t he touchstone of economic reality is whether an outside lender would have made the payments in the same form and on the same terms 89_tc_816 an advance that is far more speculative than what an outsider would make is obviously a loan in name only fin hay realty co f 2d pincite see laidlaw transp inc t c m cch pincite finding advance to be equity where highly- leveraged borrower could not have borrowed full amount from an outside lender the evidence shows that cse could easily have borrowed dollar_figure million from an outside lender drs chambers and shaked credibly testified that an out- side lender would have evaluated cse’s creditworthiness by considering all of its assets including the assets of its lower-tier operating subsidiaries dr shaked explained that the cse group at the relevant times had an equity cushion of dollar_figure billion to dollar_figure billion with very little outside debt respondent’s experts mr grien and dr hubbard agreed with this assessment cse would likely have qualified for a s p credit rating of at least bbb which was investment grade mr chigas accordingly opined that if cse in had sought to borrow dollar_figure million in the credit markets investors would very likely have lent money to it on substan- tially the same terms as did csa respondent points out that the cse note lacked standard covenants that would often appear in a bond sold to third-party investors these might include negative covenants restricting payment of dividends requiring maintenance of working_capital restricting mergers and sales of assets or restricting future issuance of senior debt but for intercompany loans the absence of such provisions is not surprising csa would logically rely on itw its ultimate parent to prevent cse from taking steps that would endanger either company’s financial integrity as we have recognized previously certain credit protections are not as important in the related-party context so that an intercompany loan may understandably offer more flexible terms than could be obtained elsewhere na gen p’ship subs t c m cch pincite in determining whether the purported borrower could have secured credit from third parties we do not apply a mechanical test of absolute identity between the related-party advances and open-market credit transactions nestlé holdings inc t c m cch pincite sustaining debt characterization despite absence of covenants requiring maintenance of working_capital restricting sales of assets and restricting dividend payments rather our objective is to determine whether an unrelated lender would have extended credit on substantially_similar economic terms see na gen p’ship subs t c m cch pincite sustaining debt characterization despite evidence that borrower would have paid an interest rate up to basis points higher if it had borrowed in the credit markets dollar_figure mr chigas credibly testified that investment grade debt generally need not include financial covenants and that the addition of restrictive covenants like those discussed above would have had no material effect on investor perceptions a third-party lender would have evaluated cse’s creditworthiness by considering its excellent capital structure low debt profile strong historical and projected earn- ings and eligibility for an investment grade credit rating concluding as we do that a third-party lender would have extended credit to cse on essentially the same economic terms as csa did we find that this last factor favors character- izing the advance as bona_fide debt conclusion our determination as to whether the cse loan constituted genuine indebted- ness rather than a dividend does not depend on a mechanical counting of factors but on evaluating the transaction as a whole see hardman f 2d pincite 17while mandating interest at a rate of the note did not require that cse pay interest periodically petitioner’s experts agreed that in this respect the cse note differed from standard third-party debt mr chigas credibly testified that this interest-deferral option equated to a fairly minor benefit in the range of to basis points cse in fact paid interest annually at the rates required by the and notes the ultimate question we must decide is whether at the time of the withdrawals the taxpayer intended to repay them busch f 2d pincite in making this determination we do not treat any single factor as dispositive frierdich f 2d pincite we have considered factors in our analysis nine factors favor debt treatment four seem neutral or unhelpful here and only one factor favors dividend treatment several factors--evidence of the intent to repay cse’s ability to repay the existence of all conventional indicia of debt and cse’s ability to borrow from third parties on similar economic terms--favor petitioner rather strongly the one factor that favors respondent--cse’s status as csa’s sole shareholder--would ex- ist in any holding-company structure and thus carries somewhat less weight here evaluating these factors and the transaction overall we find that the cse note constituted bona_fide debt iii application of judicial doctrines respondent urges that we deploy one or more judicial anti-tax-avoidance doctrines to recharacterize the repatriation transaction as a dividend to petitioner or paradym petitioner replies that once the court has applied the traditional debt-vs -dividend analysis outlined above the substance of the transaction is established and cannot be recharacterized using common_law theories as explained below we agree with petitionerdollar_figure a economic_substance_doctrine taxpayers may generally structure their business transactions in a manner that minimizes tax_liability see 552_us_421 n citing 293_us_465 however as has long been established courts may look beyond the form of a transaction to its sub- stance to determine how the transaction should be treated for tax purposes see eg 435_us_561 248_f3d_572 7th cir aff’g tcmemo_1999_425 the economic_substance_doctrine as applied by most courts has objective and subjective components the objective element considers whether a transac- tion meaningfully changes the taxpayer’s economic position and the subjective element considers whether the taxpayer has a valid nontax business_purpose see 779_f3d_448 7th cir aff’g t c memo 18petitioner contends that respondent bears the burden_of_proof on this issue because it is a new_matter pleaded in the answer rule a re- spondent contends that because the arguments discussed in the text do not require different evidence or increase the deficiency he did not raise a new_matter in his answer see 112_tc_183 because we de- cide this issue on a preponderance_of_the_evidence we need not decide who has the burden_of_proof see sec_7491 estate of turner t c pincite grojean f 3d pincite the seventh circuit has noted that even when a transaction has some degree of nontax economic_substance the substance-over-form principle may provide an independent justification for recharacterizing it feldman f 3d pincite we find both elements of the economic_substance_doctrine satisfied here the economic reality of the transaction is that csa made a loan to cse and cse made a distribution to paradym this pair of transactions meaningfully changed the parties’ economic positions csa now had a dollar_figure million asset on its books cse was obligated to repay a dollar_figure million liability with interest and paradym received a distribution that enabled petitioner to pay down its cp indebt- edness because the transfer of funds from csa to cse was a loan in substance as well as in form neither the economic_substance_doctrine nor the substance- over-form principle can be used to metamorphose the loan into a dividend contrary to respondent’s assertions the intercompany nature of the transfers does not mean that the parties’ economic positions did not change respondent relies heavily on dr hubbard’s theory that csa had an implied liability to fund repayment of the cse note--a liability that supposedly offset the loan asset on its books--because cse as a holding_company lacked operating earnings_of its own we have rejected those arguments in concluding that the cse loan was bona_fide debt see supra pp n those arguments do not become any more persuasive when tendered in support of an economic_substance position we also find that the transaction was supported by a valid nontax business_purpose as the seventh circuit has held w hether withdrawals by a share- holder from a corporation are treated for tax purposes as loans or dividends turns on whether the taxpayer intended to repay them busch f 2d pincite we have determined that cse intended to repay the advance and that it was a loan execution of that loan had a valid nontax business_purpose securing funds for appropriate corporate use here paying down the parent’s outstanding cp bal- ance the fact that the parties used a debt transaction to fund this pay-down in- stead of a dividend that may have been more costly tax-wise does not imbue the transaction with an invalid purpose see gregory u s pincite the legal right of a taxpayer to decrease the amount of what otherwise would be his taxes or altogether avoid them by means which the law permits cannot be doubted for all these reasons we see no possible application of the economic_substance doc- trine on these facts b step_transaction_doctrine under the step_transaction_doctrine formal steps in a transaction may be disregarded for tax purposes if the taxpayer could have achieved its objective more directly but instead included the step for no other purpose than to avoid u s taxes 251_f3d_210 d c cir aff’g tcmemo_1999_411 see 137_tc_70 aff’d 728_f3d_676 7th cir as we explained in 78_tc_350 the step_transaction_doctrine generally applies in cases where a taxpayer seeks to get from point a to point d and does so stopping in between at points b and c the whole purpose of the unnecessary stops is to achieve tax consequences differing from those which a direct path from a to d would have produced in such a situation courts are not bound by the twisted path taken by the taxpayer and the intervening stops may be disregarded or rearranged the step_transaction_doctrine has no application here respondent contends that the advance by csa to cse and the distribution by cse to paradym were mutually interdependent steps that should be collapsed into a dividend from csa to petitioner but csa could not have paid a dividend to paradym or petitioner because neither was a shareholder of csa any distribution by csa would first have to go to cse its parent_corporation in reality respondent is not seeking to collapse unnecessary steps but to recharacterize the first step as a dividend rather than a loan we have rejected that argument for the reasons set forth abovedollar_figure 19respondent erroneously cites barnes grp inc v commissioner tcmemo_2013_109 105_tcm_1654 aff’d 593_fedappx_7 2d cir continued both parties seek support for their positions from 604_f2d_1045 7th cir rev’g and remanding tcmemo_1977_93 36_tcm_417 in that case a subsidiary_corporation s planned to sell an appreciated asset and expected to recognize a large taxable gain its parent cor- poration p which had no e_p at that point obtained a loan from a third-party bank and used the loan proceeds to make a return-of-capital distribution to its par- ent a partnership the partnership used those funds to repay its own loan to the same bank in effect substituting p for itself as the bank’s obligor s sold the ap- preciated asset three days later but that sale closed in p’s next taxable_year s then used a portion of the sale proceeds to make a loan to p which used those funds to repay the loan it had obtained from the bank id pincite continued as support for his position the taxpayer there caused a cfc to transfer cash to a newly formed bermuda entity in exchange for stock that cash was then trans- ferred to a newly formed delaware corporation in exchange for stock and the delaware corporation purportedly lent the cash to the u s parent we ruled for the commissioner finding that the separate steps in this transaction should be collapsed and that the cash transferred by the cfc was in substance a dividend by it to the u s parent id pincite our holding was based on the taxpayer’s failure to respect the formalities of its own transactions in particular the failure by the u s parent to pay interest to the delaware corporation ibid here by contrast the formalities of the transaction were uniformly respected and were consistent with the substance viz the execution of a loan from csa to cse and whereas the cfc in barnes grp could have paid a dividend directly to its u s parent as the first and only step of the transaction csa could not have paid a dividend directly to paradym because paradym did not own any csa stock the taxpayer treated these transactions as a loan followed by a return-of- capital distribution in p’s first taxable_year which resulted in no taxable_income to the partnership the commissioner challenged this treatment under the step trans- action doctrine contending that all of the steps should be collapsed and be deemed to have occurred in p’s second taxable_year concurrently with the asset sale in that event the e_p generated by the asset sale would tier up to p the intercom- pany loan would disappear and p’s distribution to the partnership would be a tax- able dividend rather than a tax-free return_of_capital the seventh circuit reversing this court held that the separate steps of the transaction should be respected and that t he transaction viewed as a whole did have economic_substance id pincite it viewed falkoff as a case where a cor- poration without accrued or present earnings_and_profits borrowed against its own appreciated assets and made a distribution in anticipation of future profits ibid s uch a distribution the court held does not result in taxable_income to the shareholder ibid this court in falkoff had concluded that the partnership rather than p was the true obligor on the bank loan that the partnership had provided p with the funds to make the distribution in year one that the year-one distribution involved a circular flow of funds and hence lacked economic_substance and that the rele- vant distribution occurred after the asset sale in year two when p--now flush with e p--issued a constructive_dividend to the partnership by repaying the bank loan see falkoff t c m cch pincite the seventh circuit rejected that analysis concluding that p was the true obligor on the bank loan and that the distributee partnership had not provided funds enabling the corporation to make a sham distribution back to itself falkoff f 2d pincite but even if the bank loans were thought to be shams the seventh circuit held that the relevant taxable event--the year-one distribution--occurred in a taxable_year in which p had no e_p thus no taxable_income would be due in any event id pincite although there are factual differences between falkoff and the instant case we think falkoff helps petitioner much more than it helps respondent the basic transaction in both cases is the same a corporation without accrued or current e_p here cse borrowed against its appreciated assets and made a return-of- capital distribution to its parent here paradym in anticipation of future profits here earnings expected from csa’s operating subsidiaries see id pincite the main factual difference is that cse borrowed from an affiliate whereas p the distributing_corporation in falkoff borrowed from a third-party bank but this factual difference requires not that we collapse the transactions but simply that we subject them to greater scrutiny ie determine whether the cse loan was a true loan having determined that it was a true loan we regard it as functionally equivalent to a bank loan that being so the basic facts of falkoff are essentially similar to those heredollar_figure the seventh circuit unambiguously rejected the commissioner’s applica- tion of the step_transaction_doctrine to these facts indeed it noted that our court had also rejected at least in part the commissioner’s step transaction approach id pincite in falkoff we observed that p the distributing_corporation had every right to pay a dividend out of borrowed funds in the taxable_year ending septem- ber in anticipation of the realization of gain which would cover that dis- tribution in the subsequent year falkoff t c m cch pincite citing 23_tc_756 aff’d 236_f2d_612 2d cir that observation is not helpful to respondent in this case we ruled for the commis- sioner in falkoff on a different theory namely that the distributee partnership ra- 20another factual difference is that the transactions in falkoff were split be- tween two tax years whereas the key transactions here all occurred during the split between two tax years however was relevant only to the seventh cir- cuit’s alternative holding under which it would have sustained the taxpayer’s position even if the bank loans were thought to be shams see falkoff f 2d pincite the split between two tax years had no bearing on the seventh circuit’s primary holding as set forth in the text respondent also notes that the parties in falkoff were domestic corporations whereas csa and cse were cfcs this distinction relates to respondent’s subpart_f avoidance theory which we discuss below see infra pp ther than the distributing_corporation was the true obligor on the bank loan that argument is not available to respondent here in sum we are unpersuaded by respondent’s invocation of the step transac- tion doctrine on the facts presented here the seventh circuit in falkoff clearly rejected application of that doctrine and the facts of this case are similar in all critical respects to the facts of falkoff c conduit doctrine contending that cse served no purpose in the repatriation transaction re- spondent invokes a conduit theory to reach the same bottom line as his step trans- action theory namely that csa in substance paid a dividend directly to paradym out of csa’s accumulated e_p under the conduit doctrine a court may disre- gard an entity if it functions as a mere conduit in implementing a prearranged transaction see 324_us_331 385_f2d_244 7th cir in court holding co a corporation made a liquidating_distribution of appreciated_property to its shareholders who immediately sold the property to a buyer in a transaction that the corporation had arranged in advance the supreme court held that the corpor- ation in reality had effected the sale and that the shareholders were mere conduits employed in an effort to have the asset sale taxed at lower rates we reject respondent’s conduit theory for the same reasons we have rejected his step transaction theory csa could not have paid a dividend directly to para- dym because paradym owned no csa stock see supra p because cse own- ed of csa’s stock respondent errs in asserting that cse served no pur- pose in the transaction and cse cannot be regarded as a conduit for the trans- mission of a dividend from csa through it to paradym because as we have held the transfer from csa to cse was not a dividend but was a loan d subpart_f avoidance respondent contends that petitioner should not be allowed to repatriate the earnings_of its foreign subsidiaries and yet avoid u s income_taxation under sub- part f according to respondent it would thwart the policies underlying the in- ternational tax provisions to permit a permanent repatriation of foreign earnings without taxation allowing petitioner to repatriate funds in this manner would produce in respondent’s view a disparate outcome compared to a similarly sit- uated domestic shareholder that received a loan from a foreign_subsidiary see sec_956 c c requiring subpart_f inclusion where cfc makes an invest- ment in united_states_property defined to include an obligation of a united_states_person as petitioner correctly notes neither sec_951 nor sec_956 applies to the transactions at issue the characterization of csa’s advance to cse is govern- ed by familiar debt-vs -dividend principles which apply alike to foreign and to domestic corporations see eg 108_tc_590 and the distribution by cse to paradym is governed entirely by sec_301 which does not by itself implicate any international tax concerns respondent appears to contend that the policies underlying the subpart_f regime require us to recharacterize these transactions in an extraordinary way we decline respondent’s invitation in the absence of a clear statutory directive supporting his positiondollar_figure respondent seeks to distinguish falkoff along similar lines noting that the entities involved there were domestic corporations as opposed to cfcs but the commissioner advanced a similar policy argument in falkoff and the seventh circuit rejected it the commissioner of course has argued that to reverse the tax court’s judgment would permit taxpayers to determine for 21in his amended answer respondent contended that csa’s loan to cse should be recharacterized as a loan directly to petitioner or one of its domestic subsidiaries yielding an investment in u s property under sec_956 at trial respondent abandoned this argument because the purported investment if the court were to find it such would have been made during csa’s fye date and thus could not have affected petitioner’s tax_liability for themselves the time and manner of taxation in frustration of congressional directive and with prejudice to the federal fisc we think our decision will have no such dire consequence we believe the taxpayers here did no more than use the characteristics of the tax system to their best advantage the situation here is an unusual one--a corporation without accrued or current_earnings_and_profits but with substantial assets against which it can borrow to make a cash distribution to its shareholders yet even here the effect is only to delay not escape taxation the corporation’s future earnings_and_profits will be taxed as dividends when distributed falkoff f 2d pincite2 respondent replies that we should be less sanguine about future distribu- tions of profits where cfcs are involved profits may be held offshore indefinite- ly respondent notes and e_p do not tier up to a foreign holding_company as they do inside a u s consolidated_group but i f the draftsman’s handiwork fell short of fully accomplishing the objectives sought it must be left to congress to repair such shortfall 68_tc_979 dollar_figure 22on four occasions the treasury_department has proposed changing the law to reduce taxpayers’ ability to use leveraged distributions to effect repatria- tions of foreign earnings see department of the treasury general explanations of the administration’s fiscal_year revenue proposals date general explanations of the administration’s fiscal_year revenue proposal sec_55 date general explanations of the administration’s fiscal_year revenue proposal sec_59 date general explanations of the ad- ministration’s fiscal_year revenue proposals date congress did not enact any of these proposals iv tax consequences of distribution in date cse distributed dollar_figure to paradym a member of petitioner’s u s consolidated_group sec_301 provides that the portion of a distribution which is a dividend as defined in sec_316 shall be included in gross_income sec_316 provides that the term ‘dividend’ means any distribution_of_property made by a corporation to its shareholders out of current e_p or out of e_p accumulated after date the parties agree that cse had no current or accumulated e_p for the year in which it made the distri- bution to paradym thus no portion of the distribution was a dividend sec_301 provides that the portion of a distribution which is not a dividend shall be applied against and reduce the adjusted_basis of the stock sec_301 provides that the portion of a distribution which is not a divi- dend to the extent that it exceeds the adjusted_basis of the stock shall be treated as gain from the sale_or_exchange of property paradym owned of cse’s stock and these provisions require that we determine its basis in that stock a todd miller report the taxpayer generally bears the burden of substantiating its basis in pro- perty see 271_f2d_44 9th cir aff’g tcmemo_1957_193 with a view to discharging that burden petitioner offered at trial the expert testimony of todd miller who performed a detailed basis study for this purpose mr miller is a partner in the transaction advisory services practice of ernst young ey he has performed more than basis studies during his career and he formerly headed the ey group that specializes in this field petitioner contends that mr miller should be qualified as an expert because he provided specialized knowledge in the area of basis calculation respondent contends that mr miller should be treated at most as a summary witness whose summary of transactions underlying paradym’s basis in cse might be useful to the court having reserved ruling on this at issue at trial we now express our agree- ment with respondent rule of the federal rules of evidence defines an expert witness as one who is qualified as an expert by knowledge skill experience training or educa- tion an expert witness may testify in the form of an opinion if his scientific technical or other specialized knowledge will help the trier of fact to understand the evidence id para a see 526_us_137 509_us_579 a lay witness may not offer an expert opinion see fed r evid this court regularly hears testimony from irs revenue agents who describe the methodology they employed--eg the bank_deposits method or the net_worth method--to reconstruct a taxpayer’s unreported income we have generally treated such witnesses as summary witnesses not experts reasoning that they are not pro- viding an opinion based on scientific technical or other specialized knowledge see eg worth v commissioner tcmemo_2014_232 108_tcm_522 citing gudenschwager v commissioner tcmemo_1989_6 56_tcm_1010 aff’d 666_fedappx_692 9th cir like an irs reve- nue agent mr miller testified as to the data he collected the observations he made about those data and the methodology he followed in calculating paradym’s basis see worth t c m cch pincite holding that revenue agent’s testi- mony would be accepted not for the purpose of demonstrating the correctness of her methodology but solely for the purpose of explaining what she did mr miller’s methodology required him to characterize certain transactions as taxable or tax-deferred in doing this he was not offering a legal opinion as to the appropriate tax treatment of these transactions rather he was performing a mechanical sorting of entries to compile and characterize the voluminous trans- actions by which paradym acquired basis in cse see eg 549_f3d_19 1st cir the key to admissibility is that the sum- mary witness’s testimony does no more than analyze facts already introduced into evidence and spell out the tax consequences that necessarily flow from those facts other courts have held that a lay witness may offer tax-related calculations if they are straightforward and transparent see eg 515_f2d_892 5th cir dollar_figure although mr miller’s testimony fell outside the scope of rule he was competent to testify under rule of the federal rules of evidence as a sum- mary witness to explain how he performed his basis study the latter rule permits the use of a summary chart or calculation to prove the content of voluminous writings that cannot be conveniently examined in court provided that the underlying information was disclosed to the opposing party respondent agrees that the records underlying mr miller’s basis study were properly disclosed to him we conclude that mr miller appropriately testified as a summary witness to 23we are unpersuaded by petitioner’s contention that mr miller’s analysis was akin to a forensic accountant’s although both types of witnesses rely on books_and_records to make their determinations forensic accountants go beyond sorting book entries and may apply specialized knowledge to determine whether a taxpayer has engaged in fraudulent activity see 628_f3d_1032 8th cir summarize otherwise admissible data and his testimony has been admitted into evidence for that purposedollar_figure b basis substantiation mr miller relied on a variety of business records to document the trans- actions relevant in determining paradym’s basis in cse these records included among other things third-party purchase agreements intercompany purchase agreements sec_338 elections and third-party valuation reports using these records he found distinct transactions occurring between date and date that generated basis in cse most of these transactions were contributions by entities within the itw group mr miller noted that certain of these transactions resulted in carryover_basis rather than basis determined by the current fair_market_value of property after performing his analysis mr miller concluded that paradym’s basis in cse exceeded dollar_figure billion more than four times the amount needed to cover cse’s distribution of dollar_figure respondent contends that petitioner has failed to substantiate paradym’s basis in cse because petitioner did not provide complete business records to 24to the extent respondent contends that the documents on which mr miller relied to determine paradym’s basis constituted inadmissible hearsay we reject that argument all of mr miller’s determinations were linked to documents and data that were admitted or would be admissible into evidence and he properly tes- tified about how he used those documents to calculate paradym’s basis mr miller petitioner’s tax returns standing alone cannot substantiate paradym’s basis and certain distributions were improperly reflected on information returns which allegedly caused mr miller’s basis calculations to be inflated at trial james batory a senior revenue_agent in the irs large_business_and_international_division testified that he was unable to determine paradym’s basis in cse because petitioner submitted inconsistent documentation to him and because he had difficulty tracking basis-generating transactions on account of these supposed difficulties he determined paradym’s basis in cse to be zero we find that petitioner has adequately substantiated basis of at least dollar_figure contrary to respondent’s view mr miller relied on comprehensive and reliable business records to determine basis we need not parse each trans- action he analyzed because we find that three of the transactions generated basis of dollar_figure million which is sufficient to cover the distribution at issue in date premark feg premark then cse’s sole shareholder made a dollar_figure million capital_contribution to cse this contribution was made in cash the record establishes that this transaction was properly treated as a sec_351 contribution and recorded as such on all relevant books_and_records maintain- ed by the itw group in date premark made a dollar_figure million capital_contribution to cse this contribution took the form of a note issued by another itw entity with cse issuing shares in exchange for receiving the note with a carryover_basis the record establishes that this transaction was properly treated as a sec_351 contri- bution and recorded as such on all relevant books_and_records maintained by the itw group in date inhold then cse’s sole shareholder contributed to cse a dollar_figure million credit facility that it had purchased from petitioner cse issued shares in exchange for receiving this credit facility with a carryover_basis the record establishes that this transaction was properly treated as a sec_351 contribution and recorded as such on all relevant books_and_records maintained by the itw group taken together these three transactions establish basis of dollar_figure million in cse under the principle set forth in 435_f2d_1257 4th cir petitioner was required to apply the distribution to paradym on a pro_rata basis across each block of cse stock in his analysis mr miller conclud- ed that cse had blocks of stock he further concluded that each block of stock had more than enough basis to absorb a return-of-capital distribution we find this analysis to be correct respondent contends that petitioner’s tax returns and related workpapers are unreliable sources to verify basis but he does not point to any specific defects in these documents although he asserts that petitioner has failed to provide suf- ficient documentation both parties stipulated all of the documents on which mr miller relied mr miller credibly testified that he went well beyond petitioner’s tax returns to determine basis consulting the itw group’s corporate records for numerous transactions and he explained that he made conservative assumptions --viz assumptions against petitioner’s interest--in several instances where he was not entirely sure how to characterize a particular transaction even if petitioner’s documentation were deemed inadequate in certain re- spects the parties agree that we may apply the cohan_rule to estimate basis see 39_f2d_540 2d cir shank v commission- er tcmemo_2018_33 at applying the cohan_rule to estimate basis in stock kerr v commissioner tcmemo_1990_155 same cf 66_tc_695 applying similar principles to determine basis in other_property 42_tc_273 huzella v commissioner tcmemo_2017_210 at wheeler v commissioner tcmemo_2014_204 108_tcm_388 were we to apply the cohan_rule we would find that petitioner has adequately substantiated that paradym’s basis in cse was at least dollar_figure in sum we find that paradym had sufficient basis in cse to treat the entire dollar_figure distribution as a nontaxable return_of_capital under sec_301 having determined that petitioner is not liable for any deficiency for we find that it is not liable for any accuracy-related_penalty under sec_6662 for that year to reflect the foregoing decision will be entered for petitioner petitioner’s expert witnesses appendix william chambers dr chambers earned his b a in history and eco- nomics from the college of wooster and his m a in philosophy and ph d in eco- nomics from columbia university currently he is an associate professor emeritus of finance at boston university metropolitan college he has substantial experi- ence as a debt ratings analyst having rated hundreds of companies’ debt issuances he previously worked as a debt analyst and a corporate ratings and risk solutions executive for s p for years charles chigas mr chigas earned his b a in economics from tufts university and his m b a from amos tuck school currently he is the head of the debt capital markets group at natixis securities america and the managing partner of orea thea advisory a consulting firm he has worked in the debt capi- tal area for almost years during which time he has been involved with thous- ands of corporate bond transactions saul froomkin mr froomkin earned his ll b and ll m from the university of manitoba law school he is currently serving as queen’s counsel in bermuda is an officer of the most excellent order in the british empire and is a justice of the peace and fellow for the society of advanced legal studies pre- viously he served as the solicitor general of bermuda from to where he was senior counsel to the government on civil and criminal matters he also served as attorney_general of bermuda from to israel shaked dr shaked earned his b a in economics b a in stat- istics m b a in finance and a ph d in business administration finance from harvard university currently he is a finance and economics professor at boston university school of management and a managing director of michel-shaked group where he works as a corporate adviser and litigation consultant he has published extensively in the area of corporate finance and valuation and serves on the board_of the american bankruptcy institute journal respondent’s expert witnesse sec_1 robert c grien mr grien earned his b a in political science from tulane university and his m b a with a concentration in finance from columbia university mr grien is currently the managing director and head of the finance restructuring practice at tm capital corp an investment banking firm r glenn hubbard dr hubbard is a professor of economics and finance and dean of the graduate school of business at columbia university he earned his b a and b s degrees from central college of florida and his m a and ph d in economics from harvard university he has authored three tax textbooks published articles in numerous peer-reviewed journals has served on several journal editorial boards and was previously a member of the council of economic advisers