Opinion ID: 2973623
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Heading: Fixed Rate of Interest and Interest Payments

Text: The first factor to which we look is whether or not a fixed rate of interest and fixed interest payments accompanied the advances. Roth Steel, 800 F.2d at 631. The absence of a fixed interest rate and regular payments indicates equity; conversely, the presence of both evidences debt. Id.; 7 Mertens Law of Fed. Income Tax’n § 26:28 (“A fixed interest rate is indicative of a deductible interest payment.”) (collecting cases). In its findings of fact, the Tax Court determined that the advances were made with a 10% annual return rate. The court also found that Indmar made regular monthly interest payments on all of the advances. The fixed rate of interest and regular interest payments indicate that the advances were bona fide debt. In its analysis, however, the Tax Court took a different view. Rather than analyzing these facts within the Roth Steel framework (i.e., as objective indicia of debt or equity), the Tax Court focused instead on why the Rowes made the advancements: it concluded that the Rowes No. 05-1573 Indmar Prods. Co. v. Comm’r Page 7 “characterized the cash transfers as debt because they wanted to receive a 10-percent return on their investment and minimize estate taxes.” Indmar, 2005 T.C.M. LEXIS 31, at . Yet, neither of these intentions is inconsistent with characterizing the advances as loans. For tax purposes, it is generally more important to focus on “what was done,” than “why it was done.” United States v. Hertwig, 398 F.2d 452, 455 (5th Cir. 1968). “In applying the law to the facts of this case, . . . it is ‘clear that the objective factors . . . are decisive in cases of this type.’” Raymond, 511 F.2d at 191 (quoting Austin Village, 432 F.2d at 745). It is largely unremarkable that the Rowes wanted to receive a return from their advances. Most, if not all, creditors (as well as equity investors) intend to profit from their investments. Bordo Prods. Co. v. United States, 476 F.2d 1312, 1322 (Ct. Cl. 1973). As long as the interest rate is in line with the risks involved, a healthy return on investment can evidence debt. Of course, “[e]xcessively high rates would . . . raise the possibility that a distribution of corporate profits was being disguised as debt. Were such the purpose of an exorbitant interest rate, the instrument involved would probably not qualify as debt in form.” Scriptomatic, Inc. v. United States, 555 F.2d 364, 370 n.7 (3d Cir. 1977) (citing William T. Plumb, Jr., The Fed. Income Tax Significance of Corporate Debt: A Critical Analysis & A Proposal, 26 Tax L. Rev. 369, 439-40 (1971)). The Tax Court found that the 10% rate exceeded the federal prime interest rate during most of the period at issue, as well as the rate charged by FTB on several of its loans to Indmar. The record indicates that the 10% rate was not an “exorbitant interest rate” under the circumstances. Indmar had a collateralized line of credit with FTB, which, similar to the stockholder advances, was available for short-term working capital. The rate charged by FTB for the line of credit ranged between 8%-9.5%, a rate not much below the fixed rate of 10% charged by the Rowes. The rate differential makes financial sense when considering the2 differences in security – the FTB line of credit was secured while the Rowes’ advances were not. As for the Rowes’ desire to minimize their estate taxes, this also offers little to the analysis. “Tax avoidance is entirely legal and legitimate. Any taxpayer ‘may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.’” Estate of Kluener v. Comm’r, 154 F.3d 630, 634 (6th Cir. 1998) (quoting Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934) (L. Hand, J.)). The desire to avoid or minimize taxes is not itself directly relevant to the question whether a purported loan is instead an equity investment. Rather, such a desire is only tangentially relevant, by acting as a flag to the Commissioner and courts to look closely at the transaction for any objective indicia of debt. Far from proving the Commissioner’s position, the existence and consistent payment of a fixed, reasonable interest rate strongly supports the inference that the advances were bona fide loans.