Opinion ID: 3010690
Heading Depth: 4
Heading Rank: 2

Heading: Other Objective Factors

Text: The other objective characteristics of the transaction are equally inconsistent with the existence of a bonafide debt. While the Tax Court noted that the transfers were not accompanied by any notes, interest charges, collateral, repayment schedules, or book entries recording a loan balance, the court found the absence of these factors _________________________________________________________________ borrowed on margin from E.F. Hutton . . . were transferred to the Estate from the Trusts. App. at 131. The E.F. Hutton Statements reflect a margin loan balance that increased from $2,103,506 as of May 1984 to $2,850,408 as of August 1984, see app. at 184, 178, for a total increase of $746,902 during that period. Several courts have refused to characterize a transfer as a bona fide loan where, as here, the transferor did not establish a maximum loan amount but continued transferring funds at the transferee's request. See Haag, 88 T.C. 617; Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324, 1328-29 (1971), aff 'd, 496 F.2d 876 (5th Cir. 1974) (table); Roschuni v. Commissioner, 29 T.C. 1193, 1202-04 (1958), aff 'd, 271 F.2d 267 (5th Cir. 1959). 16. The Tax Court found that the trusts received additional repayments when the estate transferred mortgages to the trusts as a partial debt settlement. See Geftman, 72 T.C.M. (CCH) at 821. However, as discussed more fully below, the trusts never received any beneficial interest in the mortgages. Even assuming that the trusts had acquired some interest in the mortgages, the June 11, 1985 document making adjusting journal entries and characterizing the purported mortgage transfer as a partial debt settlement was contradicted by contemporaneous documents describing that purported transfer as a purchase. See app. at 135c. Thus we find no evidence to support the assertion that the trusts received additional repayments in the form of a mortgage transfer, and accordingly confine our analysis of the repayments to the $82,764 which the trusts actually received. 19 insignificant on the grounds that such features were not necessary in transactions between related parties. See Geftman, 72 T.C.M. (CCH) at 820-21. To the contrary, however, cases examining transactions between related parties have found the absence of such factors highly significant and have characterized transfers as bona fide loans only where the record contains sufficient objective evidence of an enforceable obligation to repay and a reasonable expectation of repayment. In Baird v. Commissioner, 43 T.C.M. (CCH) 1173, 118081 (1982), the court recognized a bona fide debt between related parties because the transferee had executed promissory notes establishing a payment schedule and charging interest at a rate of ten percent, and had delivered the notes to the transferor prior to . . . receiving the checks, while the transferor had recorded the disbursements on its books as loans. Similarly, in American Processing & Sales Co. v. United States, 371 F.2d 842 (Ct. Cl. 1967), the court found sufficient evidence of an enforceable obligation to repay and a reasonable expectation of repayment in a transaction between related corporations, inasmuch as the transferor held a lien on the transferee's buildings and fixtures and both corporations recorded consistent, definite amounts due on the debt. See id. at 845-46, 856-57. Likewise, in Litton Bus. Sys., 61 T.C. 367, the transferee corporation adopted a resolution prior to the transfer authorizing the corporation to borrow from its parent corporation, and at the time of the transfer both the transferor and transferee recorded the same opening balance of the amount owed by the subsidiary. Moreover, the indebtedness and its essential terms were recorded on the books of both companies and in a substantial amount of correspondence which set forth the existence of a debt obligation, the amount thereof and payments thereon,[and] the provision for interest. Furthermore, the interest rate was reasonable[ ] in light of the prevailing interest rates in the financial community at that time, thedue date [was] within the control of the creditors, and there was a reasonable expectation, at the inception of the [transaction], of repayment . . . based on the[transferee's] established financial history. See id. at 376-80. 20 The Tax Court cited cases such as Baird, American Processing, and Litton for the proposition that the absence of certain formalities may be excused when the transferor and transferee are related entities. See Geftman , 72 T.C.M. (CCH) at 820-21. The court failed to acknowledge, however, that although the courts in those cases did not require the presence of every possible indicium of indebtedness, they did not recognize a debt in the absence of all objective indicia, but rather based their recognition of a debt on numerous objective factors not present in this case. 17 While the foregoing cases demonstrate that the courts have required objective indicia of an obligation to support assertions of indebtedness between related parties, perhaps more significantly, numerous cases, including those relied upon by the Tax Court, have rejected assertions of indebtedness between related parties despite the presence of significant objective evidence that the transfer was intended as a loan. For instance, in Donisi v. Commissioner, 26 T.C.M. (CCH) 327 (1967), aff 'd, 405 F.2d 481 (6th Cir. 1968), the court rejected the assertion that a shareholder's transfers to his closely held corporation were bonafide loans, although the transferee, prior to the transfers, had adopted a formal resolution authorizing it to borrow from the transferor at specified interest rates, had computed and recorded the interest owed on its books, and had made several payments designated explicitly as interest owed on the loans. The court found these factors insufficient, inasmuch as the transferor did not require any notes or other written evidence of indebtedness, and did not establish a repayment schedule or obtain any collateral although the transferee had assets of a kind which _________________________________________________________________ 17. Apart from Baird, American Processing, and Litton, the Tax Court cited only one case that characterized a transfer between related parties as a bona fide debt. That case also relied on objective factors not present in this case, such as a duly executed promissory note and consistent treatment of the transfer on the parties' books andfinancial statements as loan receivables. See Shaken v. Commissioner, 21 T.C. 785, 793 (1954). However, the Shaken court's conclusion that the transfers were loan repayments also rested in large part on an analysis of factors which undermined the Commissioner's assertion in that case that the transfers constituted dividends, an analysis that is inapposite in this case. 21 normally are considered excellent security. Id. at 330. Thus, in Donisi, although the parties had manifested an intent to create a loan through objective factors such as contemporaneously stated interest rates and book entries consistent therewith, the court found it significant that the transferor, like the trusts in this case, did not take readily available measures, such as obtaining notes or collateral, to ensure repayment. In Georgiou, 70 T.C.M. (CCH) 1341, the court found that transfers from a corporation to its shareholder were not bona fide loans, although the corporation had obtained a security interest in the shareholder's assets, established a fixed maturity date, charged the shareholder interest, treated the transfers as loans on its books, and received funds back from the shareholder which the corporation explicitly designated as loan repayments. Despite these objective indicia of indebtedness, the court found that the transfers did not give rise to a bona fide debt, since there was no indication that the shareholder intended toenforce the debt against himself. Id. at 1351. Thus, contrary to the Tax Court's finding that the relatedness of the parties obviated the need for objective evidence of indebtedness, Georgiou demonstrates that even extensive objective evidence may be insufficient to establish the existence of a debt where the close relationship between the transferor and the transferee leaves the transferor discretion as to whether to enforce the debt, rendering any obligation to repay conditional rather than unconditional. Likewise, in Gilbert, 74 T.C. 60, the court rejected the assertion that a transfer constituted a bona fide loan although the transfer was consistently treated as a loan on the books . . . and balance sheets of both corporations, the check . . . included a notation that it was a loan, and the transfer subsequently was repaid in full. Id. at 65. The court found that the characterization of the transfer as a loan on these documents was unpersuasive, since the transferor did not charge interest, obtain a note, require collateral, impose a repayment schedule, or take other measures to ensure repayment. Moreover, the transferor had borrowed the same money at interest and had no business purpose . . . to have subsidized the transferee by 22  `loaning' the same funds without requiring the payment of at least an equivalent rate of interest. Id. at 66. Finally, the transferee's financial difficulties, which raised doubts as to whether the transferee would have funds available to repay, demonstrated that the transfer was economically unreasonable as a loan transaction and precluded the court from recognizing a bona fide indebtedness. Id. Virtually all of the factors that weighed against recognition of a debt in Gilbert are present in this case where the trusts borrowed funds at interest, transferred them to the estate without charging an equal rate of interest and obtaining notes, collateral, or repayment schedules, and without any basis for believing that the estate would be in a position to repay the funds transferred.18 The foregoing cases demonstrate that, contrary to the view adopted by the Tax Court, the mere relatedness of the parties is not a sufficient basis to support characterization of a transaction as a debt in the absence of objective evidence of indebtedness such as notes, collateral, repayment schedules, interest charges, or other measures demonstrating an intent to secure repayment. Rather, these cases demonstrate that transfers between related parties cannot be characterized as bona fide loans unless the totality of the objective evidence reveals that the transferee had an enforceable obligation to repay the sums transferred. The transactions in this case, which did not involve any notes, collateral, repayment schedule, interest charges, or book entries reflecting a loan, bear virtually none of the objective attributes which denote a bonafide _________________________________________________________________ 18. The Commissioner argues, br. at 26-27, that Gilbert is distinguishable because in this case the trusts earned $82,764 in interest whereas in Gilbert the transferor received no interest payments. This argument is circular, as the $82,764 cannot be characterized as interest earned by the trusts unless the trusts' $2.85 million transfer to the estate can be characterized as a bona fide loan based on sufficient objective indicia of an intent to secure repayment. The argument also is unsupported by the record, as the trusts did not charge any interest but merely recovered a portion of the E.F. Hutton interest charges which they incurred in obtaining funds for the estate. Because the trusts recovered only a portion of the $133,627 in interest they paid to E.F. Hutton, see app. at 328, they subsidized the transaction, just as the transferor did in Gilbert, with no economic advantage to themselves. 23 loan, and closely resemble transfers which the courts have refused to characterize as a genuine loan because the transferor failed to take available measures to secure repayment.19 Accordingly, wefind that the objective attributes of the transactions between the trusts and the estate cannot support the Tax Court's conclusion that they gave rise to a bona fide indebtedness. _________________________________________________________________ 19. The Tax Court cited several other cases which, like those discussed above, refused to characterize transfers between related parties as bona fide loans although they bore more objective attributes of a loan than did the transfers in this case. See In re Indian Lakes Estates, Inc., 448 F.2d 574, 578-79 (5th Cir. 1971) (finding that transfer was not a loan in economic substance despite issuance of bonds withfixed maturity dates and interest rates); Wood Preserving Corp. of Baltimore v. United States, 233 F. Supp. 600, 605-07 (D. Md. 1964) (finding that advances were not bona fide loans, despite notation of debt in ledger, as transferee made no enforceable promise to repay and could not have obtained such funds from any reasonable banker on its own credit), aff 'd, 347 F.2d 117 (4th Cir. 1965); Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324, 1328-29 (1971) (holding that disbursements, although recorded on books as balance due and although partially repaid, were not bona fide loans absent notes, maturity dates or repayment schedules), aff 'd, 496 F.2d 876 (5th Cir. 1974) (table); Astleford v. Commissioner, 33 T.C.M. (CCH) 793 (1974) (finding that transfers were not bona fide loans despite interest-bearing promissory notes, notes receivable account entered on books, and significant repayments), aff 'd , 516 F.2d 1394 (8th Cir. 1975); Chism Ice Cream Co. v. Commissioner, 21 T.C.M. (CCH) 25 (1962) (finding that transfer was not bona fide loan despite ledger account entitled note receivable and eventual repayment of entire balance, where no promissory notes were executed or delivered, no interest was charged or paid, and no collateral was given), aff 'd, 322 F.2d 956 (9th Cir. 1963). Notably, in each case cited by the Tax Court as well as in virtually every other case of which we are aware, it was the taxpayer who sought to establish the existence of a bona fide debt while the Commissioner contested its existence. In this case, by contrast, the typical positions are reversed and it is the Commissioner who seeks to prove the existence of a genuine indebtedness. The transfer, however, falls far short of the standards which the Commissioner has advocated and which the courts have adopted in the cases analyzing whether a transfer constitutes a debt. 24