department of the treasury internal_revenue_service washington d c date cc intl br6 tl-n-5950-96 wli number release date uilc internal_revenue_service national_office field_service_advice memorandum for northern california district_counsel cc sf tl attn kevin croke from steven a musher chief cc intl br6 subject this field_service_advice responds to your memorandum dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be used or cited as precedent legend a group b c d group e group counsel f country x country y country z year year year year year year year year dollar_figurej dollar_figurek dollar_figurem dollar_figuren dollar_figureo dollar_figurep dollar_figureq dollar_figurer dollar_figures dollar_figuret dollar_figureu dollar_figurev issue whether pursuant to sec_1_482-2 the commissioner may allocate interest_income to b with respect to b’s advances to c in order to reflect an arm’s length transaction when b asserts upon examination that its treatment of the advances as debt was a mistake and that the advances were equity conclusion the commissioner pursuant to sec_1_482-2 proposes to allocate interest_income to b with respect to b's advances to c in order to reflect an arm's length transaction b’s assertion upon examination that its treatment of the advances as debt on its tax returns and financial statements was a mistake and that the advances were equity subjects b to a heightened standard of proof under the rule_of law enunciated in 417_us_134 and its progeny in order for b to sustain its position b must come forth with sufficient evidence to satisfy the heightened standard of proof by demonstrating that b and c consistently respected and reported the advances as equity and that the other facts and circumstances justify treating the advances as equity based on the facts presented there is no evidence to support that b and c consistently respected the advances as equity and other circumstances herein do not justify treating the advances as such facts b is a wholly-owned domestic subsidiary of a group and it was incorporated to hold and manage investments in year b organized c a wholly-owned foreign_subsidiary in country x to act as the holding_company for its foreign ventures and to make equity investments in start-up companies to finance the foreign joint ventures b advanced a total of dollar_figurej to c over a five year period year sec_2 through of this amount dollar_figurek were transferred before january year and the remaining balance of dollar_figurem were advanced during the taxable years at issue year sec_4 through b recorded these advances on its books under the intercompany receivable account titled due from c the board_of directors minutes for year sec_3 through indicated that b advanced the following amounts as equity investments in c board_of directors minutes year year year year total advance for equity_investment dollar_figuren dollar_figureo dollar_figurep dollar_figureq dollar_figurev thus out of the total advances of dollar_figurej dollar_figurev appears related to common equity investments in c although b declared these advances as equity investments such amounts could not be traced or matched against the actual cash tranfers that were made to c during the respective tax years b’s books also contained a separate asset account titled capital_investment - c that was used to reflect b’s equity_investment in c throughout year that account had a consistent balance of dollar_figureu due to a change in b’s accounting system in year and the resulting consolidation of certain accounts no information is available concerning the subsequent balance in capital_investment - c however the aforementioned advances of dollar_figurev that were allegedly equity contributions to c does not appear to have been recorded in that account in connection with b’s year federal and state_income_tax returns b prepared a memorandum dated may year addressing its concerns about the current and future treatment of the advances to c for both book and u s tax purposes the memorandum stated that b originally planned to have the advances treated as equity contributions for u s purposes and as interest-free debt for country x’s purposes if the planning was implemented for all of year the transfers to c should be booked as capital contributions for u s tax and gaap rather than as debt the debt classification invites the question of whether interest has been paid or imputed under u s tax rules i hope to get your consent to book a reclassification of the debt to equity for year and future years this assumes the corporate resolutions are not inconsistent t he debt classification helped b’s foreign exchange position by having a debt which moves with exchage rates rather than equity there is no indication that b acted in accordance with this memoradum by reclassifying the advances as equity in year or subsequently classifying the advances as equity in year sec_4 through for book and u s tax purposes to memorialize some of the advances that were made during year sec_4 through b and c executed two written agreements dated december year and october year each advance agreement contained the following december year advance agreement effective december year b has advanced dollar_figurer to c for funding c's interest in a foreign joint_venture with d group in country y the parties agreed that the terms and conditions set forth below shall apply to of b’s present and all future advances to c maturity_date the advances shall be repaid no later than years after december year and shall be repaid upon first demand by b if c is given days written notice any repayment shall be subordinated to any claims made by general creditors stated_interest the advances bear no interest prepayment rights c has the right to prepay all or any part of the advances at any time provided days prior written notice is given acceleration clause in the event c a becomes insolvent b admits in writing that it is unable to pay its debts as they mature c undertakes any proceeding pursuant to bankruptcy or insolvency laws or d undertakes or is subject_to dissolution or liquidation proceedings then the advances shall become immediately due and payable payment all payments due under this agreement shall be made by c in freely transferable and convertible currency withholding reimbursement if c is required to withhold a tax levy duty or charge from any payment made under this agreement c shall reimburse b by way of indemnification the amounts so withheld october year advance agreement pursuant to the share acquisition agreement dated june year c agreed to purchase a ownership_interest in e group a country z company for dollar_figures b will advance dollar_figuret to c for purposes of this acquisition under the following terms and conditions maturity_date the advances shall be repaid no later than years after october year and shall be repaid upon first demand by b if c is given days written notice any repayment shall be subordinated to any claims made by general creditors stated_interest the advances bear no interest prepayment rights c has the right to prepay all or any part of the advances at any time provided days prior written notice is given acceleration clause in the event c a becomes insolvent b admits in writing that it is unable to pay its debts as they mature c undertakes any proceeding pursuant to bankruptcy or insolvency laws or d undertakes or is subject_to dissolution or liquidation proceedings then the advance shall become immediately due and payable payment all payments due under this agreement shall be made by c in freely transferable and convertible currency withholding reimbursement if c is required to withhold a tax levy duty or charge from any payment made under this agreement c shall reimburse b by way of indemnification the amounts so withheld for u s financial statements and tax reporting purposes b reflected the advances as loans to c and booked the respective amounts as intercompany receivable due from c consistent with b’s reporting c then recorded a corresponding intercompany payable in its financial statements and country x tax returns footnote of c’s financial statements titled subordinated loan from shareholder stated that c obtained a subordinated loan from b on an interest-free basis and that repayment is not expected within years this repayment period appears to coincide with the time period in which b projected a profitable net return on c’s investment in d group b submitted a twenty-two page position letter dated january year claiming that the advances were mistakenly classified as debt the advance agreements were executed for purposes of foreign tax planning in country x and the advances in substance constitute equity contributions to c in support of point b argues that the advances were mistakenly classified as debt by outside compliance professionals who failed to consider the actual nature of the advances while preparing b’s income_tax returns as for point b claims that the advances to c were documented by advance agreements for purposes of minimizing c’s country x tax_liabilities in particular b wished to reduce the amount of country x’s capital_tax on the advances made to c qualify for a participation_exemption on dividends received with respect to c's investments in d group and e group and reduce the dividend withholding_tax imposed by country x to explain the foreign tax planning objectives b submitted a letter from counsel f dated may year which addressed country x’s law on capital and withholding taxes for country x’s purposes b used a debt-equity allocation of -15 because that ratio would allow c to limit its country x tax_liabilities for three reasons first under country x’s law there are two separate tax regimes eg capital_tax and corporate tax with their own distinct debt-equity characterization rules advances that may be categorized as loans under the capital_tax regime can be considered equity contributions for purposes of the corporate tax system under the capital_tax system a tax is imposed on equity contributions received by c equity is defined as risk-carrying capital and any funds that are provided to an entity on credit that gives rise to a claim against the entity generally do not constitute risk- carrying capital by apportioning of the advances as loans c limited it sec_1 capital_tax exposure to of the advances received from b in addition a contribution of informal capital may result from interest-free debt obligations because a debtor benefits from not having to incur interest_expense related to interest-free loans the capital_tax regime treats the forgiven interest_expense as informal capital contributions to the corporation and imposes the capital_tax on the foregone interest commencing with year c imputed a contribution to its capital equal to the amount of the forgiven interest and paid the capital_tax thereon to country x counsel f also stated that in order for debt to exist based on country x’s civil law the debtor is under an obligation to repay the amount advanced apart from this feature there is no other determining characteristic of a loan in fact a loan is not required to be in any particular form and may bear high interest or not interest at all since the advance agreements must be repaid on demand upon days notice and in any event no later than years the advance agreements are properly characterized as a loan rather than capital under country x’s civil law secondly country x has determined that a debt-equity_ratio of -15 satisfies its requirement of adequate capitalization country x informally adopted these percentages as a safe_harbor debt-equity_ratio to avoid issues of thin_capitalization and thereby allowing country x corporations to receive a participation_exemption by obtaining a deduction for dividends received from equity investments country x has denied the participation_exemption to corporations that were thinly capitalized by using the safe_harbor debt-equity_ratio c avoids the issue of thin_capitalization and thus qualify for a deduction related to dividends received from its equity investments in d group and e group lastly country x also imposes a withholding_tax on dividends_paid to non-country x shareholders by classifying of the advances as debt c can avoid the dividend withholding_tax because any payment to b must first be applied against the outstanding debt counsel f’s letter states that based on country x’s jurisprudence the civil law ‘form’ in which funds are provided is generally determinative yet for purposes of country x’s corporate tax and withholding_tax debt may be recharacterized as equity in the event of a sham_transaction that is when parties present something as a loan which in reality determined under civil law should be characterized as capital the debt will be recharacterized as equity and distributions to the shareholder may nevertheless be subject_to_withholding tax with respect to point above b argues that interest_income under sec_482 may only be imputed with respect to bona_fide indebtedness to determine if an advance is bona_fide debt the substance and not the form controls its determination b cited numerous cases in support of the position that debt-equity determinations are based on substance including tam on the issue of imputed_interest under sec_482 based on the case law and the tam b claims that the subject advances are not characteristic of debt due to the extended maturity_date of years the expectation of repayment is dependent upon the success of c corp ’s investments the mere contractual right to enforce repayment is insufficient when the lender takes none of the customary steps to guaranty repayment in the event the purported borrower’s business fails the advances were subordinated to the interest of other creditors the intent of the parties to treat the transaction as equity the thin_capitalization and the inability of c to obtain funds from independent lenders further the resolution of debt-equity issues under u s law does not depend on ‘debt’ characterization pursuant to country x’s rules law and analysis the commissioner’s proposed interest adjustment under sec_482 is predicated on treating the advances made by b to c as debt sec_482 allows the commissioner to distribute income or deductions between or among commonly controlled taxpayers as may be necessary in order to prevent distortion_of_income and expenses and to clearly reflect the true tax_liability of the taxpayers 453_f2d_1144 2nd cir cert_denied 407_us_934 an allocation to reflect an arm’s length rate of interest may be made under sec_482 with respect to bona_fide indebtedness between controlled taxpayers sec_1_482-2 interest on bona_fide indebtedness provides in pertinent part i in general where one member of a group of controlled entities makes a loan or advance directly or indirectly to or otherwise becomes a creditor of another member of such group and either charges no interest or charges interest at a rate which is not equal to an arm’s length rate of interest as defined in paragraph a of this section with respect to such loan or advance the district_director may make appropriate allocations to reflect an arm’s length rate of interest for_the_use_of such loan or advance ii application of paragraph a of this section- a interest on bona_fide indebtedness paragraph a of this section applies only to determine the appropriateness of the rate of interest charged on the principal_amount of a bona_fide indebtedness between members of a group of controlled entities including- loans or advances of money or other consideration whether or not evidenced by a written instrument and indebtedness arising in the ordinary course of business from sales leases or in rendition of services by or between members of the group or any other similar extension of credit b alleged indebtedness this paragraph a does not apply to so much of an alleged indebtedness which is not in fact a bona_fide indebtedness for example paragraph a of this section does not apply to payments with respect to all or a portion of such alleged indebtedness where in fact all or a portion of an alleged indebtedness is a contribution_to_capital of a corporation or a distribution by a corporation with respect to its shares payments made with respect to alleged indebtedness including alleged stated_interest thereon shall be treated according to their substance see sec_1_482-2 sec_1_482-2 coordination with interest adjustments required under certain other code sections provides the order in which different provisions of the code shall be applied in determining the interest adjustment under sec_482 subdivision i of this regulation states first the substance of the transaction shall be determined for this purpose all the relevant facts and circumstances shall be considered and any law or rule_of law assignment_of_income step transaction etc may apply sec_1_482-2 examples provides that the principles of sec_1_482-2 may be illustrated by inter alia example an individual a transfers dollar_figure to a corporation controlled by a in exchange for the corporation’s note which bears adequate_stated_interest the district_director recharacterizes the transaction as a contribution to the capital of the corporation in exchange for preferred_stock under paragraph a i of this section sec_1_482-2 does not apply to the transaction because there is no bona_fide indebtedness in general the substance rather than the form of a transaction governs for federal_income_tax purposes 324_us_331 293_us_465 thus the commissioner has been allowed to discount the form of a transaction and determine the tax consequences based on its substance see 293_us_465 641_f2d_376 5th cir cert_denied 454_us_868 laidlaw transportation inc v commissioner tcmemo_1998_232 75_tcm_2598 this substance over form approach provided to the commissioner constitutes a rule_of law within the meaning of sec_1 a i as exemplified by the district director’s recharacterization of a note as a contribution_to_capital set forth in example supra the supreme court has also long recognized the rule_of law that a taxpayer although free to structure his transaction as he chooses once having done so must accept the consequences of his choice whether contemplated or not and may not enjoy the benefit of some other route he might have chosen to follow but did not 417_us_134 citations omitted taxpayers have less freedom than the commissioner to ignore the transactional form that they have adopted and are ordinarily bound by the tax consequences that flow therefrom 87_tc_1417 see also nestle holdings inc v commissioner 152_f3d_83 2d cir 902_f2d_439 5th cir spector v commissioner f 2d pincite 108_tc_590 99_tc_561 little v commissioner tcmemo_1993_281 65_tcm_3025 aff’d 106_f3d_1445 9th cir this rule_of law which limits a taxpayer’s ability to disavow the form of its chosen transaction seeks to avoid the uncertainty that would result from allowing the taxability of a transaction to depend on whether an alternative form exists under which more favorable tax consequences would result national alfalfa u s pincite 284_f2d_322 2nd cir the case law recognizes that taxpayers are advantaged by having both the power to structure transactions in any form they choose and the access to the facts that reflect the underlying substance in contrast the commissioner is disadvantaged because he does not have direct access to the facts underlying a particular transaction consequently the commissioner must be allowed to rely on representations made by taxpayers in their returns and must be allowed to evaluate the resulting tax consequences based on such disclosures this reliance is particularly appropriate in the context of a cross border transaction such as the present case where documents information and witnesses are not readily available to the commissioner the commissioner is justified in determining the tax effect of transactions on the basis in which the taxpayers have molded them television industries inc v commissioner f 2d pincite see also fnma v commissioner 90_tc_405 aff'd 896_f2d_580 d c cir cert_denied 499_us_974 to freely allow taxpayers to argue for alternative_tax treatment of a transaction upon the examination of the returns would be tantamount to administering the tax laws based on a policy that tax consequences flow from the transaction taxpayers have chosen or from any other form of transaction they might have chosen whichever is more favorable 103_tc_481 quoting television industries inc v commissioner f 2d pincite aff’d 70_f3d_142 d c cir see also harris v united_states f 2d pincite taxpayers may not in hindsight recast the transaction as one that they might have made in order to obtain tax advantages for this reason the courts have generally subjected taxpayers to a heightened standard of proof before they are permitted to contradict the form and have the transaction taxed in accordance with their alleged substance spector v commissioner f 2d pincite estate of durkin v commissioner t c pincite fnma v commissioner t c pincite illinois power v commissioner t c pincite little v commissioner t c m pincite moreover in the context of distinguishing debt from equity for federal_income_tax purposes the application of a heightened standard of proof is particularly apt because as discussed below the intent of the parties at the time of creation of the arrangement is a major factor under substantive law a taxpayer’s treatment of an instrument as debt or equity on its federal_income_tax return is probative of such intent the courts have articulated this heightened standard of proof differently see spector v commissioner f 2d pincite for example in 378_f2d_771 3rd cir cert_denied 389_us_858 the court held that where taxpayers executed a contract containing specific terms conditions and allocations they may not alter or avoid the tax consequences of that agreement in the absence of fraud duress or undue influence in contrast the court in 598_f2d_464 5th cir determined that before a taxpayer may alter or avoid the tax consequences of a contractual arrangement the taxpayer must come forth with strong_proof that the agreement lacked economic reality the tax_court has adopted the strong_proof standard and has refused to apply danielson outside the circuits that recognize it see eg 102_tc_406 87_tc_1046 the strong_proof rule as applied by the tax_court requires a showing of somewhat more than a preponderance_of_the_evidence and somewhat less than danielson see illinois power co v commissioner t c pincite n the burden upon the taxpayer is far heavier when his tax reporting positions and other actions did not consistently reflect the substance which he later argues should control the form miller v commissioner t c m pincite citing illinois power co v commissioner t c pincite only certain courts have adopted the danielson_rule see eg 35_f3d_1570 fed cir 746_f2d_319 6th cir 730_f2d_718 11th cir cert_denied 469_us_882 spector v commissioner supra the tax_court in estate of durkin v commissioner t c pincite held that under either a strong_proof or danielson standard the taxpayers could not disavow their chosen form where taxpayers were seeking to disavow their own tax_return treatment of the transaction the taxpayers’ reporting position and other actions did not show an honest and consistent respect for the substance of the transaction the taxpayers were unilaterally attempting to have the transaction treated differently after it had been challenged and the taxpayers would have been unjustly enriched if he were permitted to belatedly alter the transaction after well-informed negotiations were held with the other party to the transaction the taxpayers in durkin did not prevail in establishing that the transaction in substance was different from that which was initially reported in the tax_return as a purchase of coal properties from their corporation at a price below fair_market_value upon examination of the returns the commissioner determined that the taxpayers received a constructive_dividend for the difference between the price paid and fair_market_value of the property after their returns were challenged by the commissioner the taxpayers argued that their purchase of coal properties were in substance part of one integrated transaction in which they disposed of their stock ownership to another shareholder and thus the transaction should be taxed as a redemption based on the four factors discussed above the tax_court determined that the taxpayers did not carry their heightened burden to show a substance that is different than their reporting position in the recent opinion of 111_tc_105 the tax_court again denied the taxpayer’s attempt to have a transaction taxed in accordance with its alleged substance after it was initially reported on the return as a sale and lease-back of real_property the taxpayer argued that there had been no sale and that the entire transaction in substance was merely a financing_arrangement after considering various approaches the tax_court concluded that the taxpayers cannot elect a specific course of action and then when finding himself in an adverse situation extricate himself by applying the age-old theory of substance over form norwest corp v commissioner t c pincite a taxpayer’s ability to ignore the transactional form that he has adopted is further curtailed if he attempts to abandon his tax_return treatment of a transaction w hen a taxpayer seeks to disavow his own tax_return treatment by asserting the priority of substance only after the commissioner raises questions with respect thereto this court need not entertain the taxpayer’s assertion of the priority of substance id pincite most notably for purposes of the present case taxpayers have been held to their characterization of transactions as debt despite their attempts to invoke traditional debt versus equity or other substance considerations see taiyo hawaii ltd v commissioner t c pincite debt versus equity city of new york v commissioner t c pincite debt versus partial debt partial grant litchfield v commissioner tcmemo_1994_585 68_tcm_1291 aff'd in an unpublished order ustc big_number 10th cir debt versus equity miller v commissioner t c m pincite debt versus equity for instance in taiyo hawaii v commissioner the u s taxpayer received advances from its foreign parent that were not evidenced by a promissory note had no fixed maturity_date or stated rate of interest and were unsecured in the financial statements and tax returns the taxpayer respected the advances as intercompany loans further at the instruction of the parent the taxpayer accrued interest_expense on the advances and deducted said interest on its tax returns upon examination the commissioner determined that the taxpayer was liable for excess_interest tax under sec_884 to avoid this tax the taxpayer attempted to disavow its characterization of the advances as debt and argued that notwithstanding the labels originally attached to the advances they were in substance capital contributions id pincite in support of its argument the taxpayer cited a past line of cases where the tax_court previously resolved debt versus equity disputes by applying the traditional debt versus equity considerations the tax_court in holding for the commissioner that the advances were debt found that it was unnecessary under the facts of the case to engage in a traditional debt versus equity analysis and relegated the cases relied upon by the taxpayer to a footnote t c pincite n and instead working from the fundamental rule_of law enunciated in national alfalfa that a taxpayer must accept the tax consequences of its choice of transaction the tax_court noted that taxpayers have been permitted to assert substance over form where their tax reporting and other actions have shown an honest and consistent respect for the substance id pincite citing fnma v commissioner t c pincite and illinois power co v commissioner t c pincite taiyo hawaii however failed to demonstrate an honest and consistent respect for what it contended after the fact was the substance of the transaction relying on cases such as estate of durkin v commissioner and 264_f2d_305 2d cir aff’g 29_tc_129 the tax_court stated 85_tc_1005 63_tc_790 30_tc_1273 lds inc v commissioner tcmemo_1986_293 51_tcm_1433 inductotherm industries inc v commissioner tcmemo_1984_281 48_tcm_167 aff’d without published opinion 770_f2d_1071 3rd cir petitioner has for all purposes treated the advances as loans and was instructed by its parent_corporation to accrue interest under those circumstances we reject petitioner's approach of testing its own choice of form with traditional debt versus equity considerations such as the absence of a fixed payment schedule maturity dates enforcement or formal debt instruments we are likewise unpersuaded by petitioner's accountant's after-the-fact testimony that in retrospect he should have considered the advances as equity and reported them as such on petitioner's tax returns petitioner’s approach does not show that the substance of the advances was not loans it merely illustrates that the parties to the transactions did not follow all the formalities that might be considered probative that the advances were debt rather than equity in that regard petitioner has not shown that the form of the transaction did not comport with its substance accordingly we hold that petitioner has not carried its burden of showing that the substance of the transaction was different from its form t c pincite citations and footnote omitted further the tax_court adopted a heightened standard of proof when a taxpayer attempted to avoid the commissioner’s interest allocation pursuant to sec_482 based on the argument of substance over form cayuga service inc v commissioner tcmemo_1975_4 34_tcm_18 in response to the taxpayer’s urging that the court disregard the form of intercompany advances as loans and find that the advances were investments the court stated i f a taxpayer asserts that the substance is different than the form he used he must furnish strong_proof that the substance was other than the form indicates citing inter alia ullman v commissioner the court found that petitioner has failed to meet is burden of persuading us that the advances were in fact investments and not loans t c m pincite the court decided cayuga service based on then existing sec_1 a t d date and the decision is consistent with longstanding judicial principles that the commissioner is allowed to determine the tax consequences of a transaction based on its substance while imposing a heightened standard of proof on taxpayers that argue for a substance different than the form unlike the regulations these judicial principles are presently set forth in sec_1_482-2 t d date and confirmed in subdivision i thereof that the substance of the transaction shall be determined by considering all the relevant facts and circumstances and any law or rule_of law assignment_of_income step transaction etc may apply although there exist a past line of cases in which some courts were willing to adjudicate debt versus equity disputes raised by taxpayers without expressly subjecting the taxpayers to a heightened standard of proof for determining the substance the court in taiyo hawaii v commissioner as mentioned above was unpersuaded as to the relevance of these cases and found them unworthy of comment in light of national alfalfa and its progeny t c pincite n and further were another court to be persuaded otherwise these cases are factually or legally distinguishable from the present case for instance in 85_tc_1005 the commissioner sought to impute interest pursuant to sec_482 on funds paid_by a subsidiary to its parent and reflected by the subsidiary as loans on its books and financial statements the subsidiary subsequently declared substantial dividends during the years in question which it credited against the recorded balances rather than paid in cash there were no written debt instruments and the subsidiary’s financial statements contained a footnote noting its intention to declare dividends if its parent were unable to repay the loaned amounts the commissioner relied upon then existing sec_1_482-2 t d date for authority to allocate the interest the taxpayer in turn argued that the transfers were corporate_distributions and relied upon then existing sec_1 a which stated that the subparagraph relied upon by the commissioner does not apply to alleged indebtedness which was in fact a contribution of capital or a distribution by a corporation with respect to its shares both parties argued numerous cases to support their respective characterizations of the funds transferred as loans or corporate_distributions the tax_court held that the transferred funds were not loans placing emphasis on the fact that the transferred funds which appeared only as accounting entries were treated as satisfying the obligation of tobin construction to pay the dividends declared id pincite1 before conducting its analysis of whether the transfers were loans or distributions the tax_court in j a tobin construction co noted the principle that a taxpayer is generally not allowed to argue that the substance of a transaction was other than the form he chose citing in re steen v united_states 509_f2d_1398 n 9th cir however the court did not subject the taxpayer to a heightened standard of proof in this case for several reasons first the court noted that the regulation relied upon by respondent placed no express restriction on a taxpayer’s as distinguished from respondent’s ability to challenge the bona_fide nature of the loan and nothing in the regulation suggests that only respondent can make that argument second respondent did not argue that the taxpayer as a matter of law is held to the form of the transaction and finally the court found that under the circumstances both the form and substance were in dispute and after considering all the facts the advances were dividends in form and substance id pincite3 640_f2d_1296 cl_ct is equally distinguishable on similar grounds in sum j a tobin construction co is distinguishable from the present case because the taxpayer did not disavow its initial tax_return position and the commissioner did not argue that the taxpayer was held to the form of the transaction as a matter of law whatever doubt the court may have had about the commissioner’s ability to invoke the rule_of law enunciated by national alfalfa and its progeny within the purview of an interest allocation under sec_482 had the commissioner so chosen would now be alleviated by the language of the present regulation which makes clear that the commissioner may determine the substance of the transaction and that for this purpose all the relevant facts and circumstances shall be considered and any law or rule_of law may apply the tax_court was also willing to consider the debt versus equity issue in georgia- pacific corp based on the substance of the transaction due to the exceptional circumstances involved in that case the taxpayer in georgia-pacific acquired the assets of colortype co which included a receivable for advances made by colortype to its subsidiary the commissioner argued that since the taxpayer was colortype’s transferee the taxpayer was bound by the form in which colortype characterized the advances prior to the acquisition colortype executed a note agreement containing stated_interest and maturity_date both colortype and its subsidiary accrued interest_income and corresponding expense on their financial statements and tax returns the taxpayer argued that as of the year in question there had been a change in the economic circumstances of the business and the advances made by colortype had been transformed into equity the court opined that w hile a taxpayer must in other contexts normally accept the tax consequences of the way in which he deliberately chose to cast his transaction advances of the type here involved must be characterized in terms of economic reality for the year at issue changing circumstances as time passes may alter the original character of an advance and transform it into equity therefore the taxpayer was not bound by the form in which it cast this transaction id pincite the court in any event determined that the character of the advances were debt the georgia-pacific opinion is distinguishable in that the transaction was created by the taxpayer’s predecessor moreover the court obviously weighed the taxpayer’s historic evidence of intent including statements noted on the returns as significant factors in its decision as such the opinion does not support the proposition that when faced with a taxpayer seeking to disavow its form and argue debt versus equity considerations a court would feel compelled to take a different tack than that in taiyo hawaii with respect to the present case b should be subject_to the heightened standard of proof when it attempts to argue substance by rebutting its own tax_return treatment of the advances that were originally reported as debt under these circumstances b must demonstrate that b and c consistently recognized and respected the advances as capital contributions b’s initial federal_income_tax return position is probative of b’s and c’s intent to treat the advances as debt the numerous documents eg internal memorandum corporate resolution advance agreements and c’s foreign tax disclosures demonstrate that b’s tax reporting position and other actions do not show an honest and consistent respect for what it now claims to be in substance equity contributions to c the memorandum dated may year indicates that b realized that its classification of the advances as debt raises the issue of whether interest has been imputed under u s tax rules it was recommended that if the advances were intended to be equity investments in c they should be reclassified from debt to equity provided that such reclassification is not contrary to b’s corporate resolutions by recategorizing the advances it would eliminate any concerns regarding imputed_interest however b did not reclassify any of the advances for u s tax purposes and the corporate resolutions for year sec_3 through only authorized a portion of the advances dollar_figurev to be treated as equity investments in c as such b’s inaction coupled with the corporate resolutions exemplify that b neither respected nor intended for the entire advance of dollar_figurej to be treated as capital the other cases cited by the taxpayer in taiyo are also distinguishable from the present matter in 30_tc_1273 the commissioner determined that the taxpayer had forgiveness of indebtedness income but the tax_court found that the advances in questions were contributions to capital the commissioner did not argue that the heightened standard of proof should apply and the case predated the supreme court’s opinion in national alfalfa furthermore it is not clear that the taxpayer disavowed any prior return position as for the decision in lds inc v commissioner 51_tcm_1433 although the court analyzed the substance of the transaction by applying the traditional debt-equity factors it determined that the taxpayer proved the substance by proffering strong_proof that all factors taken collectively weighed in favor of equity furthermore in inductotherm industries inc v commissioner t c m pincite the court allowed advances to be characterized as equity but the commissioner did not argue that the heightened standard of proof applies when a taxpayer argues for substance different from its reporting position contributions consequently b’s conduct negates its argument that the advances were mistakenly classified as debt by outside compliance professionals since b was cognizant of the issues surrounding the manner in which it reported the advances in cases involving cross border transactions the tax_court will take into account the global structure of the transaction including foreign tax disclosures for instance in 87_tc_178 the tax_court examined all the facts surrounding the cross border leasing transaction between the u s lessee and u k lessor in determining whether the former had a depreciable_interest in the leased equipment prior to the lease arrangement the u k lessor transferred its title and ownership_interest in the equipment to the lenders hence the u s lessee could not acquire a depreciable_interest in the equipment since his interest flows from that of the u k lessor by claiming depreciation_deductions the u s lessee was in fact attempting to disavow the form of the transaction that was originally structured between the u k lessor and the lenders the court stated t he fact that the purpose underlying the form of the transaction between the u k lessor and the lenders was to take advantage of u k rather than u s tax laws does not in our opinion provide a sufficient foundation for permitting petitioners to disavow that form in order to obtain the benefits of u s tax laws moreover there is no established judicial principles which compels us to ignore the form of a transaction structured to obtain tax benefits in one jurisdiction and to restructure the transaction at the insistence of the taxpayer in order to confer tax benefits in another jurisdiction - in short to enable the taxpayer to play both ends against the middle like coleman the tax_court in laidlaw transportation inc v commissioner t c m pincite also reviewed the structure of the advances on a global basis the dispute in laidlaw involved the characterization of cross border advances that were made between controlled taxpayers and classified as debt the commissioner challenged the substance of the transactions arguing that the advances constituted equity in holding for the commissioner the tax_court noted that the advances were structured in a manner that ultimately created a double deduction to the canadian parent on a global basis id pincite the canadian parent borrowed funds from an independent lender and transferred these funds as capital contributions to a wholly-owned netherlands subsidiary the netherlands subsidiary in turn loaned those funds with stated_interest to u s sister companies that were also wholly-owned by the canadian parent under this structure the canadian parent deducted interest on its loan with the outside lender and the u s subsidiaries deducted interest on its borrowings from the netherlands subsidiary during an examination of the parent’s returns the parent represented to the canadian tax authorities that the advances were capital contributions to the subsidiaries id pincite the tax_court viewed this representation as a significant factor in establishing the parent’s intent that the advances were equity investments id pincite in light of coleman and laidlaw the advance agreements and c’s country x tax reporting are likely to serve as further corroboration that b did not honestly and consistently respect the substance of the advances as alleged equity the advance agreement dated december year states that b structured of all present and future advances to c as debt c’s position is that the advances qualify as debt pursuant to country x’s law because c acknowledges that it is under an obligation to repay the funds to b in accordance with the terms of the advance agreements hence both b and c respected the advances as debt and reported the transactions as such in their respective tax returns although c did not deduct any interest_expense on these non-interest bearing advances the amount of the foregone interest has nevertheless been indirectly recognized by c as additional informal capital_contribution under country x’s capital_tax regime accordingly c accrued and paid the capital_tax with respect to the foregone interest recognizing the foregone interest and reporting the advances as loans in the financial statements and tax returns of both jurisdictions are probative of an intent that the advances were debt hence these facts do not establish that b and c respected the advances as capital contributions b’s inconsistent conduct also shows that it is unilaterally disavowing the outbound aspect of the advances as equity to avoid u s tax consequences while maintaining c’s corresponding treatment of the same advances as non-interest bearing debt in order to obtain country x’s tax benefits in transactions involving controlled taxpayers as in this case where c is wholly-owned by b it is reasonable to expect that the parties would accord consistent and reciprocal characterization on intercompany_transactions however b’s position is that the advances may be given disharmonious characterization for purposes of obtaining tax benefits in both united_states and country x that is b treats the advances as an investment in c without the expectation of repayment but c views the advances as a loan with the intent to fully repay b within years this categorization results in a transaction that requires particular scrutiny particularly when it involves related parties like the taxpayer in coleman supra b is attempting to play both ends against the middle by disavowing the advances that were consistently recognized as debt in both jurisdictions and restructuring the u s aspect of the advances as equity for purposes of avoiding the tax consequences of sec_482 in light of the foregoing we do not believe that b has sustained its heightened burden to establish that in substance it respected the advances as capital contributions to c when in fact the parties themselves did not honestly and consistently respect the character of the advances as such in considering whether b can produce sufficient evidence to demonstrate that b and c consistently respected and reported the advances as equity and that the other facts and circumstances justify treating the advances as equity we note that no single uniform approach has been adopted by the courts in analyzing the debt versus equity factors the courts analyze whether there was a genuine intention to create a debt with a reasonable expectation of repayment and did that intention comport with the economic reality of creating a debtor-creditor relationship litton business systems inc v commissioner t c pincite courts generally look to the names given to the certificates evidencing the indebtedness the presence or absence of a maturity_date the source of the payments the right to enforce payment of principal and interest participation and management a status equal to or inferior to that of regular corporate creditors the intent of the parties thin or adequate capitalization identity of interest between creditor and stockholder payment of interest only out of dividend money and the ability of corporation to obtain loans from outside lending institutions 827_f2d_1409 9th cir citing 748_f2d_1365 9th cir a r lantz co v united st424_f2d_1330 9th cir o h kruse grain milling v commissi279_f2d_123 9th cir see also laidlaw transportation inc v commissioner tcmemo_1998_232 nestle holdings inc v commissioner tcmemo_1995_441 70_tcm_682 morgan pacific corp v commissioner tcmemo_1995_418 70_tcm_540 the limited facts herein show that the advance agreements contain some indicia of debt as well as equity for the following reasons the names given to the certificates the issuance of a stock certificate indicates an equity contribution and the issuance of a bond debenture or note indicates a bona_fide indebtedness hardman v united_states f 2d pincite where the document lacks a name or the assigned name is ambiguous the court look to the language expressed in the document for instance phrases such as in consideration of or hereby agrees to pay is typical language associated with a promissory note id but see laidlaw transportation inc v commissioner t c m pincite notwithstanding how the document is labeled this factor carries less weight as compared to others while the title describing the documents herein are ambiguously labeled advance agreements the language contained therein appears indicative of a promissory note since b and c are acknowledging c’ sec_2 obligation to repay the advances on ten days’ notice and no later than years from the date of their original issuance the presence or absence of a maturity_date the absence of a fixed maturity_date indicates that repayment is tied to the fortunes of the business hardman v united_states f 2d pincite in contrast the existence of a fixed maturity_date generally indicates that the advance was debt laidlaw transportation inc v commissioner t c m pincite demand instruments with no fixed maturity_date or postponing and amending maturity dates for prolonged periods suggests that the lender does not intend to require repayment and that the transfers are equity id but see 453_f2d_1144 rolling over the notes upon maturity did not transform the advances that were treated as debt into equity for purposes of sec_482 imputed_interest b’s advance agreements are not strictly demand instruments given the existence of a fixed maturity_date of no later than years as such these advance agreements are different from the instruments discussed in laidlaw that is the agreements herein contain the absolute latest time in which c must repay the advances further there is no evidence that b either postponed or amended the original maturity_date set forth in the advance agreements the maturity term of years may not be deemed excessively long since the tax_court has upheld related_party debt_instrument with a term of years see nestle holdings inc v commissioner t c m pincite the source of payments if the recipient of the advances does not have liquid_assets or reasonably anticipated cash-flow from which to repay then the advances are likely to be equity laidlaw transportation inc v commissioner t c m pincite repayments that are dependent upon earnings_and_profits of the corporation are indicative of equity hardman v united_states f 2d pincite the facts presented to date do not establish whether c has sufficient liquid_assets or reasonably anticipated cash-flow to repay the advances to b to determine c’s liquidity consideration should be given to c’s cash position including any other asset that can be readily converted to cash such as marketable_securities further if c’s investment in d group and e group are publicly traded then such investment will also qualify as marketable_securities as for determining anticipated cash-flow c’s business plan and financial projections ascertaining the expected cash-flow in connection with c’s operations are also relevant the right to enforce payment of principal and interest the presence of an enforceable obligation to repay the funds suggests that the advances are debt hardman v united_states f 2d pincite this factor distinguishes a contractual right from an equity_interest associated with stock ownership in which there is no right to enforce payment of dividends id see also 464_f2d_394 repayment cannot be contingent upon the success of the business the key consideration here is the reservation of contractual right to enforce payment and not the exercise of such right laidlaw transportation inc v commissioner t c m pincite however when the maturity dates are repeatedly extended then the right to enforce payment becomes meaningless and such conduct could infer that the advances are equity id pincite the acceleration clause noted in the advance agreements establish that not only did b reserve the right to enforce full repayment but that such repayment was not contingent upon the success of c’s business even if c were to experience financial difficulties or insolvency and undertake dissolution or liquidation proceeding b nevertheless had the right to compel full repayment of the advances b is not taking the risks associated with an equity contribution whose return on investment is generally subject_to the fortunes or misfortunes of the corporation given that b has not repeatedly extended the maturity_date the acceleration clause weighs the advance agreements in support of debt participation in management where there is an increase in the ownership_interest of the corporation or an increase in voting rights as a result of the advances then the transaction weighs in favor of equity hardman v united_states f 2d pincite however this factor is irrelevant in b’s case since it wholly owns all the outstanding_stock of c see laidlaw transportation inc v commissioner t c m pincite therefore this factor is deemed neutral a status equal to or inferior to that of regular corporate creditors whether an advance is equal or subordinate to the claims of regular corporate creditors affects whether the taxpayer was dealing as a shareholder or creditor id the advance agreements contained a statement whereby c’s repayments are subordinated to the claims of general creditors hence this factor is indicative of equity the intent of the parties as discussed above b’s and c’s conduct manifested the intent that the advances were loans see pp of this memorandum thin or adequate capitalization a high debt to equity ratio tends to show that the obligation is unrealistic or beyond the corporation’s ability to perform hardman v united_states f 2d pincite the courts have not articulated a particular debt to equity ratio which would be considered as adequate capitalization and hence we cannot determine whether a debt to equity ratio of to would be deemed adequate identity of interest between creditor and stockholder if advances by shareholders are proportionate to their stock ownership the advances are more likely to be equity laidlaw transportation inc v commissioner t c m pincite this factor favors equity since c is wholly-owned by b but such factor is seldom decisive payment of interest only out of dividend money when advances are without stated_interest such suggests that the provider of funds is interested in the future earnings_of the corporation or the increased market_value of its interest estate of mixon v united_states f 2d pincite hence non- interest bearing advances tend to indicate equity_investment however an advance that otherwise qualifies as debt will not be transformed into equity simply because there is a lack of stated_interest or it carries inadequate interest the purpose of sec_1_482-2 is to allow the commissioner to impute interest in non-interest bearing related_party advances see 500_f2d_108 9th cir upholding commissioner’s imputed_interest under sec_482 on non-interest bearing related_party advances 486_f2d_1 8th cir imputing interest_income on non- interest bearing related_party advances with no maturity_date therefore this factor is neutral in determining whether b’s advances are debt or equity the ability of the corporation to obtain loans from outside sources if a corporation is able to borrow funds from outside sources the transaction has the appearance of a bona_fide indebtedness and indicates that the shareholder acted in the same manner toward the corporation as ‘ordinary reasonable creditors would have acted’ hardman v united_states f 2d pincite further development with this issue is required given that we have no facts concerning whether an independent creditor would agree to lend funds to c under the same conditions as provided in the advance agreements hence we cannot determine whether this factor would weigh in favor of debt or equity based on the foregoing analysis the advance agreements contain certain indicia of debt that is supported by b’s and c’s subsequent conduct manifesting their intent that the advances were loans the debt characteristics in these instruments create a further burden for b under the heightened standard of proof that the advances in question are equity as a final matter we note that tam notice_94_47 and the case sec_4 cited by b are distinguishable from the instant case first the tam cannot be cited as precedent and most notably the facts therein are different from b’s case in the tam the parent_corporation made advances to its subsidiary that was evidenced by an unsecured subordinated demand note subsequent to the issuance of the note the subsidiary experienced poor financial condition resulting in an inability to repay the advances the parent’s board_of directors adopted a resolution to convert the advances that were initially treated as debt and thereafter the parent recognized the advances as equity for book and tax purposes in concluding that the parent was not subject_to imputed_interest under sec_482 we cited 63_tc_790 for the proposition that while a taxpayer must normally accept the tax consequences resulting from the deliberate structuring of a transaction advances between a parent_corporation and a subsidiary must be characterized in terms of economic reality for the year at issue the conclusion in the tam adopts the principles set forth in georgia-pacific that recognize c hanging circumstances as time passes may alter the original character of an advance and transform it into equity georgia-pacific corp v commissioner t c pincite due to a change in the subsidiary’s financial condition which resulted in its inability to repay it was appropriate to change the character of the advances given that the economic reality of the transaction no longer resembled debt however since c is not experiencing any poor financial condition and has not expressed an inability to repay the advances to b there is no justifiable basis for b to claim that the advances should be converted to equity thus the circumstances underlying the tam differs from the instant case further 326_us_521 827_f2d_1409 9th cir 789_f2d_1341 9th cir 800_f2d_625 6th cir 730_f2d_634 11th cir in re 742_f2d_1311 11th cir 748_f2d_1365 9th cir a r lantz co v united st424_f2d_1330 9th cir 411_f2d_818 5th cir 398_f2d_694 3rd cir 367_f2d_980 5th cir 284_f2d_723 2nd cir 239_f2d_729 9th cir snitzer v commissioner 183_f2d_70 9th cir 640_f2d_1296 cl_ct 63_tc_790 30_tc_1273 kadlec v commissioner t c memo deja vu inc v commissioner tcmemo_1995_234 ginsburg v commissioner tcmemo_1992_372 lds inc v commissioner tcmemo_1986_293 inductotherm industries inc v commissioner tcmemo_1984_281 mchenry v commissioner tcmemo_1978_300 the underlying theme in determining the outcome in georgia-pacific was the intent of the parties and in the present case the intent of the parties is best evidenced by their treatment of the advances as debt until the time the service proposed an adjustment pursuant to sec_1_482-2 notice_94_47 c b is irrelevant to the present analysis the notice did not address the commissioner’s position regarding taxpayers who take inconsistent tax reporting positions by disavowing the character debt or equity that was initially adopted in their related_party advances the notice’s principal purpose was to inform the public that the commissioner intends to scrutinize instruments that have been categorized as debt for tax purposes but treated as equity for regulatory rating agency or financial_accounting purposes in this respect the notice discussed the traditional debt versus equity analysis instruments that are payable in stock and treatment of instruments with extended maturities in light of 55_tc_345 in response to the case law cited by b in support of its contention that debt versus equity disputes are resolved based on the substance of a transaction it should be noted that those cases did not involve taxpayers who were attempting to disavow their tax_return position the taxpayers therein maintained a consistent tax position regarding the form and substance of the transaction and argued that both the form and substance of the advances were debt in order to claim either a bad_debt or interest_expense_deduction it was the commissioner who challenged the claimed deductions on the grounds that the substance of the advances were not bona_fide debt but rather equity consequently b’s cases do not support the proposition that the traditional debt versus equity analysis should trump other relevant judicial principles reflective of the heightened standard of proof case development hazards and other considerations please consider that cases of this nature always involve a weighing of all facts and circumstances and that a court may be more inclined to find that a taxpayer has met its heightened standard of proof upon disavowing the form of its transaction if the debt versus equity considerations overwhelmingly favor the taxpayer particularly in light of the language of sec_1_482-2 which arguably could be read to require a substance analysis only under sec_482 see tobin v commissioner inductotherm industries inc v commissioner notwithstanding the fact that there is considerable evidence and judicial support to subject the taxpayer to a heightened standard of proof upon the commissioner’s proposed allocation of interest consideration of going forward with the adjustment should also include the overall strengths and weaknesses of the case in terms of the traditional debt versus equity approach if you have any further questions please call steven a musher chief branch office of associate chief_counsel international


internal_revenue_service p o box cincinnati oh release number release date date department of the treasury employer_identification_number contact person - id number contact telephone number legend uil x county and state y state z college b minimum amount for freshmen c minimum amount for sophomores d minimum amount for juniors dear you asked for advance approval of your scholarship grant procedures under internal_revenue_code sec_4945 this approval is required because you are a private_foundation that is exempt from federal_income_tax you requested approval of your scholarship program to fund the education of certain qualifying students our determination we approved your procedures for awarding scholarships based on the information you submitted and assuming you will conduct your program as proposed we determined that your procedures for awarding scholarships meet the requirements of code sec_4945 as a result expenditures you make under these procedures won't be taxable also awards made under these procedures are scholarship or fellowship grants and are not taxable to the recipients if they use them for qualified_tuition_and_related_expenses subject_to the limitations provide in code sec_117 description of your request your purpose is to provide scholarships to students who are residents of x and in any event shall be residents of the state of y attending z the number of scholarships that will be awarded each year and the amount of each scholarship will vary depending on the amount of funds available to be distributed the scholarship is advertised on z’s website letter catalog number 58263t each year the trustee advises the scholarship committee of the amount of funds available to be awarded as scholarship the members of the scholarship committee review the scholarship applications and rank the applicants based on financial need the scholarship committee then submits its selection to the trustee along with the amount of the award the trust document names the president and the dean of students of z as the selection committee all scholarships are awarded an objective and non- discriminatory basis no scholarship may be awarded to any disqualified_person as defined in code sec_4946 eligible students must be in need of financial assistance with a particular emphasis on diligent students who may be average scholastically and not necessarily in the upper part of the class but who will be likely to benefit in terms of personal development the trustee provides a letter to each the trustee pays the scholarship proceeds directly to the university college the recipient attends for the benefit of the recipient university college specifying that the university college’s acceptance of the funds constitutes the university college’s agreement to i refund any unused portion of the scholarship if a scholarship recipient fails to meet any term or condition of the scholarship and ii notify the trustee if the scholarship recipient fails to meet any term or condition of the scholarship trustee will obtain the needed reports and grade transcripts from the scholarship recipient if the university school will not agree to such terms the the dollar amount of each scholarship each year shall be in the sole discretion of the trust committee of the trustee but in setting such amounts the trust committee shall attempt to make the total amount of each said scholarship approximately the equivalent in economic value and benefit to the recipient to that which would have been provided by scholarship during the academic year for a student of freshmen class standing at the beginning of the academic year in the amount of b fora student of sophomore class standing at the beginning of the academic year in the amount of c fora student of junior class standing at the beginning of the academic year in the amount of d each scholarship shall be paid in such increments and at such times during the academic year as the trust committee of the trustee shall determine you will maintain case histories showing recipients of your scholarships or educational grants including names addresses purposes of awards amount of each award manner of selection and the relationship if any to officers trustees or donors of funds to you letter catalog number 58263t you will arrange to receive and review grantee reports annually and upon completion of the purpose for which the grant was awarded to investigate diversions of funds from their intended purposes and take all reasonable and appropriate steps to recover diverted funds ensure other grants funds held by the grantee are used for their intended purposes and withhold further payments to grantee until you obtain grantees assurances that future diversions will not occur and the grantees will take extraordinary precautions to prevent future diversions from occurring you will maintain all records relating to individual grants including information obtained to evaluate grantees identify whether grantee is a disqualified_person establish the amount and purpose of each grant and establish that you under took the supervision and investigation of grants basis for our determination the law imposes certain excise_taxes on the taxable_expenditures of private_foundations code sec_4945 a taxable_expenditure is any amount a private_foundation pays as a grant to an individual for travel study or other similar purposes however a grant that meets all of the following requirements of code sec_4945 is not a taxable_expenditure e e the foundation awards the grant on an objective and nondiscriminatory basis the irs approves in advance the procedure for awarding the grant the grant is a scholarship or fellowship subject_to the provisions of code sec_117 the grant is to be used for study at an educational_organization described in code sec_170 other conditions that apply to this determination e e e this determination only covers the grant program described above this approval will apply to succeeding grant programs only if their standards and procedures don't differ significantly from those described in your original request this determination applies only to you it may not be cited as a precedent you cannot rely on the conclusions in this letter if the facts you provided have changed substantially you must report any significant changes to your program to the cincinnati office of exempt_organizations at internal_revenue_service exempt_organizations determinations p o box cincinnati oh e you cannot award grants to your creators officers directors trustees foundation managers or members of selection committees or their relatives letter catalog number 58263t e e all funds distributed to individuals must be made on a charitable basis and further the purposes of your organization you cannot award grants for a purpose that is inconsistent with code sec_170 you should keep adequate_records and case histories so that you can substantiate your grant distributions with the irs if necessary please keep a copy of this letter in your records if you have questions please contact the person listed at the top of this letter sincerely director exempt_organizations letter catalog number 58263t


office_of_chief_counsel internal_revenue_service memorandum number release date cc tege eoeg et1 postn-165900-04 uilc date date to director submission processing cincinnati oh attn entity unit from office of division counsel associate chief_counsel tax exempt government entities ---------------------------------------------------- subject railroad_retirement_tax_act status in accordance with the coordination procedure established between the service and the railroad retirement board rrb the rrb has provided us with its opinion that the following business ceased to be an employer under the railroad retirement act and the railroad unemployment insurance act effective ------------------- ------------------------------------------------------- -------------------------------------------------------- ---------------- ----------------------------------------------------- we have reviewed the opinion of the rrb and based upon the information submitted to the rrb we also conclude that ---------------------------------------------------ceased to be an employer under the railroad_retirement_tax_act effective ------------------- please take the appropriate action regarding this business ---------------------------------- ---------------------------------------- ---------------------------------- --------------------------------------- joseph w spires


office_of_chief_counsel department of the treasury i n t e r n a l r e v e n u e s e r v i c e washington d c date cc pa apjp b01 genin-131039-05 number info release date uil 6050p --------------------------------------------------------------------- ---------------------------------------- ----------------------------------- attention ---------------------- dear --------------- this letter responds to your request for information dated date regarding reporting cancellation of indebtedness under sec_6050p of the internal_revenue_code code specifically you request information concerning your organization’s reporting obligations if it discharges debt based on a debtor’s inability to pay in your letter you state that your organization provides funding for oil spill removals and damage claims and seeks reimbursement from the party responsible for the oil spills occasionally while seeking to collect your organization may determine that the responsible_party is unable to pay the full amount of the debt and may settle the debt for less than the full amount owed you describe six scenarios involving responsible parties that are unable to pay the full amount of the debt or that will not settle if your organization informs them that it will file a form 1099-c cancellation of debt reporting the amount of the discharged debt in order to minimize disruptions to your organization’s collection process you would like not to send forms 1099-c if your organization determines that it is unfair or unreasonable to report the discharged debt sec_6050p of the code provides that any applicable_entity that discharges indebtedness of any person during a calendar_year must file an information_return reporting the discharge sec_6050p defines an applicable_entity as an executive judicial or legislative agency and any applicable_financial_entity sec_6050p provides that every applicable_entity required to file a return under sec_6050p must furnish an information statement to the debtor sec_6050p provides that no information reporting is required under sec_6050p if the amount of the discharge is less than dollar_figure sec_1_6050p-1 of the income_tax regulations regulations provides that upon the occurrence of an identifiable_event an applicable_entity must report cancellation of indebtedness of dollar_figure or more during a calendar_year unless an exception to reporting applies sec_1_6050p-1 provides eight identifiable events that require reporting cancellation of indebtedness sec_1_6050p-1 provides that an genin-131039-05 identifiable_event includes a discharge_of_indebtedness pursuant to an agreement between an applicable_entity and a debtor to discharge indebtedness at less than full consideration sec_1_6050p-1 provides various exceptions to reporting cancellation of indebtedness under sec_6050p including certain bankruptcy discharges interest and nonprincipal amounts in lending transactions in general under sec_6050p of the code and the regulations an applicable_entity must report cancellation of indebtedness of dollar_figure or more in a calendar_year upon the occurrence of an identifiable_event the settlement of a debt for less than the full amount owed may constitute an identifiable_event under sec_1_6050p-1 therefore unless an exception to reporting applies an applicable_entity must report cancellation of indebtedness upon the settlement of a debt for less than the full amount owed reporting under sec_6050p is mandatory not discretionary and there is no exception based on what the creditor believes would be unfair unreasonable or disruptive to its business to briefly address your concerns regarding reporting based on what the creditor thinks is unfair unreasonable or disruptive you should note the following there is no provision in sec_6050p of the code or the regulations that requires a creditor to notify the debtor that it will report cancellation of indebtedness upon a settlement sec_1_6050p-1 requires reporting cancellation of indebtedness regardless of whether or not the debtor is subject_to tax on the cancellation of indebtedness and the tax consequences to the debtor on the cancellation of indebtedness do not change whether or not the creditor files a form 1099-c reporting the discharge this letter calls your attention to certain general principles of the law it is intended for informational purposes only and does not constitute a ruling see section dollar_figure of revproc_2005_1 2005_1_irb_1 if you have any additional questions please contact our office at -------------------- sincerely donna welch senior counsel administrative provisions judicial practice procedure administration


t c summary opinion united_states tax_court millard j and jacquie m scott petitioners v commissioner of internal revenue respondent docket no 8110-04s filed date millard j and jacquie m scott pro sese charles j graves for respondent goldberg special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time the petition was filed the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority unless otherwise indicated subsequent section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure respondent determined a deficiency in petitioners’ federal_income_tax of dollar_figure for the taxable_year the issue for decision is whether petitioners received discharge_of_indebtedness income of dollar_figure in taxable_year which they failed to report we hold that they did background some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners resided in eagar arizona on the date the petition was filed in this case from date through date petitioners had three joint credit cards issued to them by mbna america bank n a mbna a statement of accounts with a closing date of date showed the balance due mbna on these accounts consisting of credit card charges balance transfers checks interest operation charges and penalties totaled dollar_figure petitioners secured a loan from a bank not identified in the record to pay off their credit card debt in an attempt to consolidate their liabilities petitioners on date made a payment of dollar_figure to mbna for settlement of their accounts mbna received said payment of dollar_figure on date as a result of this settlement transaction mbna issued a form 1099-c cancellation of debt to petitioners for taxable_year also mbna filed with respondent a form 1099-c with respect to petitioners the form 1099-c reported date as the date of the cancellation of debt and dollar_figure as the amount of debt canceled petitioners were not insolvent in nor did they file for bankruptcy during that year petitioners timely filed their form_1040 u s individual_income_tax_return for the taxable_year petitioners did not report any part of the cancellation of indebtedness on their tax_return subsequently respondent determined that petitioners failed to report on their tax_return for income_from_discharge_of_indebtedness of dollar_figure accordingly respondent issued to petitioners a notice_of_deficiency determining a deficiency of dollar_figure in petitioners’ federal_income_tax discussion as a general_rule the determinations of the commissioner in a notice_of_deficiency are presumed correct and the taxpayer bears the burden of proving the commissioner’s determinations in the notice_of_deficiency to be in error rule a 290_us_111 as one exception to this rule sec_7491 places upon the commissioner the burden_of_proof with respect to any factual issue relating to liability for tax if the taxpayer maintained adequate_records satisfied the substantiation requirements cooperated with the commissioner and introduced during the court_proceeding credible_evidence with respect to the factual issue although neither party alleges the applicability of sec_7491 we conclude that the burden_of_proof has not shifted with respect to the issue in the present case sec_61 defines gross_income as all income from whatever source derived unless otherwise provided the supreme court has consistently given this definition of gross_income a liberal construction in recognition of the intention of congress to tax all gains except those specifically exempted 348_us_426 see also 716_f2d_693 9th cir all realized accessions to wealth are presumed taxable_income unless the taxpayer can demonstrate that an acquisition is specifically exempted from taxation revg 79_tc_398 it is beyond dispute that income_from_discharge_of_indebtedness is included within the broad definition of income sec_61 sec_1_61-12 income_tax regs the underlying rationale for such inclusion is that to the extent a taxpayer is released from indebtedness he or she realizes an accession to income due to the freeing of assets previously offset by the liability 116_tc_63 citing 284_us_1 a discharge_of_indebtedness generally produces income in an amount equal to the difference between the amount due on the obligation and the amount_paid for the discharge if no consideration is paid for the discharge then the entire amount of the debt is considered the amount that the debtor must include in income sec_61 there are both statutory and common_law exceptions to the rule requiring the recognition of income from the discharge_of_indebtedness e g sec_108 81_tc_77 however these exceptions do not apply to the present case petitioners state that the instructions in the internal_revenue_service irs guidance booklet for filing a 1099-c require that only the principal of a lending transaction be taken into income as discharge_of_indebtedness income consequently petitioners argue that their outstanding credit card liability which included interest operation charges and penalties should be reduced pursuant to the instructions in the irs guidance booklet the instructions on which petitioners rely are found in the instructions for forms 1099-a and 1099-c the pertinent instructions state as follows debt defined a debt is any amount owed to you including stated principal stated_interest fees penalties administrative costs and fines the amount of debt canceled may be all or only part of the total amount owed however for a lending transaction you are required to report only the stated principal see exceptions on page ac-3 exceptions interest you are not required to report interest however if you choose to report interest as part of the canceled debt in box of the 1099-c you must show the interest separately in box nonprincipal amounts for a lending transaction you are not required to report any amount other than stated principal a lending transaction occurs when a lender loans money to or makes advances on behalf of a borrower including revolving credit and lines of credit nonprincipal amounts include penalties fines fees and administrative costs however for a nonlending transaction report any of these amounts that are included in the debt this guidance is provided by the irs to assist parties in preparing a form 1099-c first the authoritative sources of federal tax law are in the statutes regulations and judicial decisions and not in informal publications provided by the irs zimmerman v commissioner 71_tc_367 affd without published opinion 614_f2d_1294 2d cir second petitioners have not shown the total amount of interest operation charges and penalties that they claim should reduce their outstanding credit card liability third pursuant to the above-referenced instructions in a nonlending transaction such as occurred here any nonprincipal amounts are included in the debt thus it appears that petitioners are incorrectly interpreting the above- referenced instructions or are incorrectly categorizing their transaction as a lending transaction further applicable case law establishes that in situations where the facts and circumstances are such that indebtedness from a credit card account is being discharged the amount of income as a result of the discharge of this indebtedness is an amount equal to the difference between the amount due on the obligation and the amount_paid for the discharge or if no consideration is paid for the discharge then the entire amount of the debt is considered the amount of income that the debtor must include in income see earnshaw v commissioner tcmemo_2002_191 affd 150_fedappx_745 10th cir accordingly we conclude that petitioners received discharge_of_indebtedness income of dollar_figure petitioners alternatively argue that the amount of dollar_figure was a reduction of charges agreed to by mbna in exchange for petitioners’ prompt payment of dollar_figure in other words petitioners argue that they contested the amount of the debt with mbna and that through negotiations it was established that dollar_figure was the total amount of petitioners’ credit card debt nothing in the record indicates that petitioners contested the amount of the credit card debt with mbna in fact mbna’s action of issuing a form 1099-c is contrary to petitioners’ contention further petitioners have not offered any documentary_evidence supporting their claims that they contested the amount of the debt with mbna and that through negotiations it was established that dollar_figure was the total amount of petitioners’ credit card debt it is well settled that we are not required to accept self-serving testimony in the absence of corroborating evidence 877_f2d_624 7th cir affg tcmemo_1987_295 99_tc_202 on the basis of the record in the present case we find that the amount of dollar_figure was not a reduction of charges but was in fact a discharge_of_indebtedness we have considered all of the other arguments made by petitioners and to the extent that we have not specifically addressed them we conclude they are without merit reviewed and adopted as the report of the small_tax_case division decision will be entered for respondent


t c summary opinion united_states tax_court edward a birts petitioner v commissioner of internal revenue respondent docket no 3914-o0s filed date fdward a birts pro_se marilyn s ames for respondent armen special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time the petition was filed ’ the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority ' unless otherwise indicated all subsequent section references are to the internal_revenue_code in effect for the taxable_year in issue - - respondent determined a deficiency in petitioner’s federal_income_tax for the taxable_year in the amount of dollar_figure the deficiency is attributable solely to the alternative_minimum_tax prescribed by sec_55 the issue for decision is whether petitioner is liable for alternative_minimum_tax we hold that he is background some of the facts have been stipulated and they are so found petitioner resided in houston texas at the time that his petition was filed with the court petitioner filed a federal_income_tax return form_1040 for on his return petitioner listed his filing_status as married_filing_separately and he claimed deductions for two personal exemptions petitioner reported adjusted_gross_income agi in the amount of dollar_figure consisting solely of wages from employment in addition petitioner itemized_deductions on schedule a in this regard petitioner claimed total deductions in the amount of dollar_figure consisting of charitable_contributions in the amount of dollar_figure and miscellaneous_itemized_deductions in the form of unreimbursed employee_expenses in the net amount of dollar_figure calculated as follows miscellaneous_itemized_deductions unreimbursed employee_expenses dollar_figure less agi net amount big_number after taking into account itemized_deductions and personal exemptions petitioner reported taxable_income in the amount of dollar_figure using the tax table prescribed by sec_3 for individuals petitioner reported tax in the amount of dollar_figure petitioner did not attach form_6251 alternative minimum tax-individuals to his return nor did petitioner report any liability for alternative_minimum_tax on his return in date respondent issued a notice_of_deficiency to petitioner for the taxable_year in the notice respondent did not disallow any of the itemized_deductions or personal exemptions claimed by petitioner on his return rather respondent determined that petitioner is liable for alternative_minimum_tax as prescribed by sec_55 in the amount of dollar_figure petitioner filed a petition contesting respondent’s deficiency determination in the petition as well as at trial petitioner contends that he is not the type of person who should be liable for alternative_minimum_tax discussion deferring for the moment the fundamental issue whether petitioner is liable for alternative_minimum_tax the following computation shows the proper amount of such tax - - i individual_income_tax_return - form_1040 adjusted_gross_income form_1040 line sec_32 dollar_figure less itemized_deductions schedule a -big_number balance form_1040 line big_number less exemptions form_1040 line --big_number taxable_income form_1040 line big_number tax sec_1 c regular_tax sec_26 a c ii itemized expenses - schedule a charitable_contributions dollar_figure miscellaneous_itemized_deductions unreimbursed employee_expenses total itemized_deductions big_number iii alternative_minimum_taxable_income taxable_income form_1040 line s big_number adjustments miscellaneous_itemized_deductions unreimbursed employee_expenses big_number exemptions balance big_number plus items of tax preference --o- alternative_minimum_taxable_income iv alternative_minimum_tax big_number alternative_minimum_taxable_income dollar_figure less exemption_amount -big_number taxable_excess big_number times applicable amt rate x tentative_minimum_tax big_number less regular_tax -619 alternative_minimum_tax big_number our analysis necessarily begins with sec_55 the section of the internal_revenue_code that imposes the alternative_minimum_tax initially we note that the alternative_minimum_tax is - - imposed in addition to the regular_tax and that the regular_tax is as relevant herein the income_tax computed on taxable_income by reference to the pertinent tax table sec_55 c see also sec_26 a in petitioner’s case the regular_tax is dollar_figure pursuant to sec_55 the alternative_minimum_tax is the difference between the tentative_minimum_tax and the regular_tax in the case of a married individual who files a separate_return and as relevant herein the tentative_minimum_tax i sec_26 percent of the excess of a taxpayer's alternative_minimum_taxable_income over an exemption_amount of dollar_figure see sec_55 a b d c sec_55 defines the term alternative_minimum_taxable_income as relevant herein the term alternative_minimum_taxable_income means the taxpayer's taxable_income for the taxable_year determined with the adjustments provided in sec_56 and increased by the amount of items of tax preference in the case of a married individual who files a joint_return with his or her spouse the exemption_amount is dollar_figure see sec_55 a it is possible therefore that petitioner might not have been liable for alternative_minimum_tax if he had filed a joint_return with his spouse however sec_6013 b b precludes the filing of a joint_return after a taxpayer files a separate_return if the taxpayer files a timely petition with this court in respect of a notice_of_deficiency for the year for which the notice is issued notwithstanding this limitation respondent offered to settle the present case ona deemed filed basis however petitioner and or petitioner’s spouse declined the offer -- - described in sec_57 petitioner had no items of tax preference in accordingly alternative_minimum_taxable_income means petitioner’s taxable_income determined with the adjustments provided in sec_56 petitioner’s taxable_income for was dollar_figure the amount reported on line of form_1040 as relevant herein the adjustments provided in sec_56 are twofold first sec_56 a states that no deduction shall be allowed for any miscellaneous itemized_deduction as defined in sec_67 such as unreimbursed employee_expenses in computing alternative_minimum_taxable_income second sec_56 eb states that no personal exemptions shall be allowed in computing alternative_minimum_taxable_income the effect of sec_56 a and b e 1s to increase petitioner’s taxable_income by dollar_figure the amount claimed on petitioner’s schedule a for miscellaneous_itemized_deductions unreimbursed employee_expenses and dollar_figure the amount claimed on petitioner’s form_1040 for personal exemptions after taking into account the foregoing two adjustments petitioner’s alternative_minimum_taxable_income for equals dollar_figure alternative_minimum_taxable_income exceeds the applicable exemption_amount of dollar_figure by dollar_figure see sec - jj - d c petitioner’s tentative_minimum_tax is therefore percent of the excess or dollar_figure sec_55 b a because petitioner’s tentative_minimum_tax exceeds the regular_tax of dollar_figure petitioner is liable for the alternative_minimum_tax in the amount of such excess ée dollar_figure less dollar_figure or dollar_figure see sec_55 petitioner does not challenge the mechanics of the foregoing computation rather petitioner contends that the alternative_minimum_tax was not meant to apply to him because he is not wealthy and had no items of tax preference the clearest expression of legislative intent is found in the actual language used by congress in enacting legislation as the supreme court has stated there is no more persuasive evidence of the purpose of a statute than the words by which the legislature undertook to give expression to its wishes 310_us_534 see 101_tc_196 controlling effect will generally be given to the plain language of a statute unless to do so would produce absurd or futile results again as the supreme court has stated in the absence of a clearly expressed legislative intention to the contrary the language of the statute itself must ordinarily be regarded as conclusive unless exceptional circumstances dictate otherwise when we find the terms of a statute unambiguous judicial inquiry is complete 481_us_454 citations and internal quotation marks omitted --- - the statutory scheme governing the imposition and computation of the alternative_minimum_tax is clear and precise and leaves on these facts no room for interpretation okin v commissioner tcmemo_1985_199 affd per curiam 808_f2d_1338 9th cir thus there is no justification in the instant case to ignore the plain language of the statute particularly where as here we have a complex set of statutory provisions marked by a high degree of specificity 83_tc_742 the alternative_minimum_tax serves to impose a tax whenever the sum of specified percentages of the excess of alternative_minimum_taxable_income over the applicable exemption_amount exceeds the regular_tax for the taxable_year see sec_55 bo a c d cf huntsberry v commissioner supra pincite alternative_minimum_taxable_income essentially means the taxpayer's taxable_income for the taxable_year determined with the adjustments provided in sec_56 and increased by the amount of items of tax preference described in sec_57 in huntsberry v commissioner supra we held that tax_preferences are a significant but not necessarily an indispensable component of alternative_minimum_taxable_income accordingly the taxpayers in that case were held liable for the alternative_minimum_tax computed in accordance with the specific provisions of sec_55 notwithstanding the fact that the - taxpayers did not have any items of tax preference for the taxable_year in issue see klaassen v commissioner tcmemo_1998_241 affd without published opinion 182_f3d_932 cir the same result applies in the present case if congress had intended to tax only tax_preferences it would have defined alternative_minimum_taxable_income differently for example solely by reference to items of tax preference instead congress provided for a tax measured by a broader base namely alternative_minimum_taxable_income in which tax_preferences are merely included as potential components absent some constitutional defect we are constrained to apply the law as written see 736_f2d_1168 7th cir affg 80_tc_783 and we may not rewrite the law because we may deem its effects susceptible of improvement 516_us_235 quoting 464_us_386 accordingly petitioner’s appeal for relief must in this instance be addressed to his elected representatives the proper place for a consideration of petitioner’s complaint is the halls of congress not here 40_tc_436 affd 331_f2d_422 cir -- - in view of the foregoing we hold that petitioner is liable for the alternative_minimum_tax reviewed and adopted as the report of the small_tax_case division in order to reflect the foregoing decision will be entered for respondent


internal_revenue_service number release date index number ------------------------------------- -------------------- ------------------------- ------------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------- id no ------------- telephone number --------------------- refer reply to cc psi b02 plr-147610-09 date date legend x --------------------- ----------------------------------------- state date year --------- ---------- ------- dear ------------------ this responds to a letter dated date and subsequent correspondence submitted on behalf of x requesting that the service grant x an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an entity classification election the facts submitted and representations made are summarized as follows x is a limited_liability_company formed on date of year under the laws of state x inadvertently failed to file a form_8832 entity classification election electing to treat x as a corporation for federal tax purposes effective date of year sec_301_7701-2 generally provides that a business_entity is any entity recognized for federal tax purposes that is not properly classified as a_trust under sec_301_7701-4 or otherwise subject_to special treatment under the internal_revenue_code sec_301_7701-3 provides that an eligible_entity with at least two members may elect to be classified as either an association and thus a corporation under plr-147610-09 sec_301_7701-2 or as a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner sec_301_7701-3 further provides that so long as a business_entity is not classified as a corporation under sec_301_7701-2 or an eligible_entity it may elect its classification for federal tax purposes sec_301_7701-3 provides that an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 by filing form_8832 entity classification election the effective date of the election cannot be more than seventy-five days prior to the date the form is filed and cannot be more than twelve months after the date on which the election is filed sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make the election sec_301_9100-2 provides the rules governing automatic extensions of time for making certain elections sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time for regulatory elections that do not meet the requirements of sec_301_9100-2 under sec_301_9100-3 a request for relief will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and granting relief will not prejudice the interests of the government based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to file a form_8832 with the appropriate service_center to elect to be treated as a corporation for federal tax purposes effective date of year a copy of this letter should be attached to the form_8832 a copy is enclosed for that purpose in addition this ruling is conditioned upon x filing an income_tax return consistent with treatment as a corporation for year within days following the date of this letter a copy of this letter should be attached to the return plr-147610-09 except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being sent to x’s authorized representative sincerely curt g wilson associate chief_counsel passthroughs and special industries by _________________________ bradford r poston senior counsel branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc