The opinion
T.C. Memo. 1999-36
UNITED STATES TAX COURT
PEOPLEFEEDERS, INC. AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10864-96. Filed February 4, 1999.
Held: Under the facts of this case, the fact that
respondent’s notice of deficiency indicated that
petitioner’s taxable years ended on June 30 of each
year rather than on the actual last day of petitioner’s
taxable years does not invalidate respondent’s notice
of deficiency and does not deprive the Court of subject
matter jurisdiction.
Held, further, Petitioner’s claimed $3,751,930 bad
debt deduction for petitioner's 1992 taxable year and
net operating loss carrybacks and carryforwards
relating thereto are denied.
Charles O. Cobb, Thomas M. Cryan, and Mark A. Krasner, for
petitioner.
Robert J. Burbank and Thomas C. Pliske, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies in
petitioner’s consolidated Federal income taxes in the respective
amounts of $28,415, $22,495, $465,115, $24,108, and $45,837
allegedly for petitioner's 1990, 1991, 1992, 1993, and 1994
taxable years.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
The issues for decision are: (1) Whether deficiency
determinations for petitioner's taxable years 1990 through 1994
were made in respondent’s notice of deficiency, as respondent
contends, or whether deficiency determinations against petitioner
for nonexistent years were made in respondent’s notice of
deficiency, as petitioner contends, making respondent’s
deficiency determinations defective and depriving the Court of
subject matter jurisdiction over petitioner's tax liabilities;
and (2) if the above issue is resolved in favor of respondent,
whether petitioner is entitled to a $3,751,930 claimed bad debt
deduction for petitioner's 1992 taxable year and net operating
loss (NOL) carrybacks and carryforwards relating thereto.
FINDINGS OF FACT
Some of the facts are stipulated and are so found.
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At the time the petition was filed, petitioner's principal
place of business was located in San Diego, California.
Prior to July 1, 1987, Karl Motsenbocker (Motsenbocker)
owned 82.5 percent of the shares of stock in Peoplefeeders, Inc.,
a closely held California corporation that was the parent
corporation of a group of affiliated corporations that owned and
operated a chain of pizza restaurants under the name of Square
Pan Pizza.
In the summer of 1987, Jeffrey Partrick (Partrick) and three
other individuals formed HPPW Restaurants, Inc. (HPPW), and on
July 1, 1987, HPPW acquired for $3,317,560 all of Motsenbocker's
shares of stock in Peoplefeeders and Motsenbocker's ownership
interest in a related partnership.
The $3,317,560 purchase price for the stock in
Peoplefeeders and for the related partnership interest was
reflected by and was to be paid as follows:
Form of Payment Amount
Cash at closing $ 167,560
Promissory notes* due:
Sept. 1, 1987 150,000
Mar. 31, 1988 1,500,000
June 30, 1992 1,500,000
Total $3,317,560
* Interest accrued on the promissory notes at
an annual rate of 3-1/4 percent over the
prime rate.1
1
After July 1, 1990, the interest rate on the June 30, 1992,
promissory note increased to 3-3/4 percent over the prime rate
and after July 1, 1991, the interest rate on the third promissory
(continued...)
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Upon HPPW’s acquisition of the stock in Peoplefeeders, HPPW
became the parent corporation of Peoplefeeders, and HPPW changed
its name to Peoplefeeders. The former Peoplefeeders corporate
entity changed its name to Square Pan Pizza Co. of California,
Inc. (Square Pan), and remained parent to other subsidiary
corporations that owned and operated restaurants. Hereinafter,
references to Peoplefeeders and to Square Pan are to those parent
and subsidiary corporate entities as they existed and operated
after the July 1987 acquisition and name change of the
corporations.
On August 11, 1987, Peoplefeeders obtained a $1.7 million
loan from California Commerce Bank (Commerce Bank), reflected by
a promissory note in favor of Commerce Bank payable in 53 monthly
installments of $32,075 with interest at 2-1/2 percent over prime
and due in full on June 5, 1992.
On March 31, 1988, using proceeds from the $1.7 million
Commerce Bank loan, Peoplefeeders paid Motsenbocker the $1.5
million due on that date relating to HPPW's acquisition of
Motsenbocker's stock interest in Peoplefeeders.
With regard both to the $1.5 million debt obligation owed to
Motsenbocker and the $1.7 million loan obtained from Commerce
Bank, the board of directors of Peoplefeeders formally acted on
and approved such debt obligations. Promissory notes were issued
(...continued)
note increased to 4-1/4 percent over the prime rate.
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by Peoplefeeders in favor of Motsenbocker and Commerce Bank
relating thereto, and the debt obligations were secured by
personal guarantees of Partrick, by corporate guarantees of
Square Pan and the other subsidiaries, and by collateralization
of the operating assets of Square Pan and the other subsidiaries.
As of early fall of 1987, Square Pan and the other
subsidiaries owned and operated 25 restaurants and other
businesses (namely, a wholesale food supplier and a food
concession). At that time, Peoplefeeders did not separately own
or operate any restaurants, and Peoplefeeders had no source of
income from any business other than Square Pan.
In the fall of 1987, Peoplefeeders purchased and began
operating one Arby's restaurant. In 1988, Peoplefeeders opened a
pizza restaurant, but it was unsuccessful and closed within
a year. In 1990, Peoplefeeders opened another pizza restaurant,
but this restaurant also was unsuccessful and closed within
a year.
Intercompany Bank Account
Each of the restaurants owned and operated by Peoplefeeders,
by Square Pan, and by the other related subsidiaries maintained
separate bank accounts at different banks, and cash receipts from
operations of each restaurant were deposited daily into the
separate bank accounts maintained by each restaurant. Three
times a week, the total cash receipts from all of the restaurants
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for the prior few days were withdrawn from the separate bank
accounts maintained by each restaurant and were transferred into
a single bank account maintained at Commerce Bank under the name
of Square Pan. This bank account will be referred to hereinafter
as the Intercompany bank account.
All of the business expenses relating to Peoplefeeders, to
Square Pan, to the related subsidiaries, as well as all of the
business expenses relating to the restaurants owned and operated
by the various related corporate entities, were paid by checks
drawn not on the separate bank accounts maintained by each
restaurant, but by checks drawn on the Intercompany bank account.
Payments made to Motsenbocker and to Commerce Bank with regard to
Peoplefeeders' loan and debt obligations described above also
were made by checks drawn on the Intercompany bank account.
For the years in issue, total cash receipts that
Peoplefeeders received and transferred into the Intercompany bank
account were sufficient in amount to cover Peoplefeeders' total
operating expenses, but they were not sufficient to cover the
loan payments Peoplefeeders owed to Motsenbocker and to Commerce
Bank. Accordingly, the difference between the total cash
receipts transferred by Peoplefeeders into the Intercompany bank
account and the total of Peoplefeeders’ expenses and loan
payments that were paid out of the Intercompany bank account
increased each year from 1987 until May 1992, as follows:
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Peoplefeeders' Expenses
Peoplefeeders' Cash Receipts And Loan Payments Paid
Taxable Transferred Into Intercompany Out Of Intercompany
Year Bank Account Bank Account Difference
1988 $ 782,266 $1,449,289 $ 667,023
1989 690,964 1,454,344 763,380
1990 902,115 1,530,067 627,952
1991 1,053,523 1,490,889 437,366
1992 927,586 2,183,805 1,256,219
Total $4,356,454 $8,108,394 $3,751,940
Books and Records
The record herein does not adequately reflect how, at the
time cash sales receipts were received by the various
restaurants, the cash receipts were recorded, if at all, on the
books and records of Peoplefeeders, of Square Pan, and of the
other related corporate entities. The evidence does not indicate
that, at the time cash receipts were received by the restaurants,
debit entries were made to a cash bookkeeping account, nor that
credit entries were made to a sales account.
The record, however, does establish that when cash receipts
were transferred from the separate bank accounts of the
restaurants into the Intercompany bank account, entries were
made, apparently for the first time, in the books and records of
Peoplefeeders, of Square Pan, and of the other corporate
subsidiaries. Again, however, the parties’ briefs and the
limited portions of petitioner's books and records that were
introduced into evidence herein are confusing, incomplete, and
unclear as to specifically how the transfers of cash into, and
the payment of expenses out of, the Intercompany bank account
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were reflected on the books and records of Peoplefeeders, of
Square Pan, and of the other related entities.
We describe below our understanding and findings, based on
incomplete and confusing evidence, of the bookkeeping entries of
Peoplefeeders and Square Pan relating to the transfer of cash
receipts into and the payment of expenses and loan payments out
of the Intercompany bank account.
Cash receipts transferred from Peoplefeeders into the
Intercompany bank account were recorded as debits (or as
increases in cash) in favor of Peoplefeeders in what was referred
to as Peoplefeeders’ Intercompany general ledger bookkeeping
account No. 1457000 (Peoplefeeders’ Intercompany general ledger
account) and as credits to what was referred to as Square Pan’s
Intercompany general ledger account No. 1457000 (Square Pan’s
Intercompany general ledger account).
Payments out of the Intercompany bank account of
Peoplefeeders’ business expenses and of Peoplefeeders’ loan
payments to Motsenbocker and to Commerce Bank were recorded as
credits to Peoplefeeders’ Intercompany general ledger account and
apparently as debits to Square Pan’s Intercompany general ledger
account.
Payments out of the Intercompany bank account of
Peoplefeeders’ expenses and loan payments were never treated or
specifically labeled in Peoplefeeders’ or in Square Pan’s books
and records as a loan from Square Pan, and the cash receipts
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transferred into the Intercompany bank account from Peoplefeeders
were never treated or specifically labeled in Peoplefeeders’ or
in Square Pan’s books and records as repayments of a loan from
Square Pan.
Also, as discussed further below, not until 1992 was the
difference between the total of the cash receipts transferred by
Peoplefeeders into the Intercompany bank account and the total of
the expenses and loan payments paid on behalf of Peoplefeeders
out of the Intercompany bank account treated in the minutes of
Peoplefeeders’ board of directors meetings as a loan to
Peoplefeeders. That difference was never reflected by a written
promissory note from Peoplefeeders in favor of Square Pan. No
interest was ever charged to Peoplefeeders with regard to that
difference. That difference was never treated or specifically
labeled in Peoplefeeders’ or in Square Pan’s Intercompany general
ledger accounts as a loan or as a discrete credit balance.
Private Placement Memorandum, 1991 Sale of Restaurants, and
1992 Board of Directors' Meeting
In 1988, Partrick attempted unsuccessfully to sell the stock
in Peoplefeeders through a private placement. In the related
private placement memorandum, no indication or disclosure was
made of any debt or loan obligation owed by Peoplefeeders to
Square Pan or to the other related entities.
Over the course of 1987 through 1991, the majority of the
Square Pan Pizza restaurants was either sold or closed. In
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November of 1991, the remaining Square Pan Pizza restaurants were
sold to Sbarro, Inc. (Sbarro), an unrelated entity. The sale of
these restaurants to Sbarro resulted in a taxable gain to Square
Pan of $1,417,271.
At the time of the sale to Sbarro, Partrick discussed the
$1,417,271 taxable gain with representatives of Arthur Andersen &
Co., who informed Partrick that deductions could be generated
that would offset the $1,417,271 taxable gain.
On May 4, 1992, at a special meeting of the board of
directors of Square Pan, the directors adopted a resolution that
purported to treat the $3,751,940 difference between
Peoplefeeders’ total cash receipts and Peoplefeeders’ expenses
and loan payments that had been paid out of the Intercompany bank
account as a $3,751,930 debt obligation of Peoplefeeders to
Square Pan and that purported to cancel that debt obligation as
uncollectible.2
In the resolution adopted by the board of directors, the
stated reason for the cancellation of the purported $3,751,930
debt obligation was that no repayments had ever been made by
Peoplefeeders on the purported debt obligation and that due to
the financial condition of Peoplefeeders there existed no
prospect of collecting any part of the debt obligation.
2
The $10 discrepancy between the $3,751,940 difference and
the $3,751,930 purported bad debt obligation is not explained in
the record. Hereinafter, we refer only to $3,751,930.
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In December of 1992, Partrick made a loan to Peoplefeeders
of approximately $600,000 with an interest rate of 4 percent over
prime. The principal amount of this loan was payable on demand.
This loan from Partrick to Peoplefeeders was approved in advance
by a resolution of Peoplefeeders' board of directors, evidenced
by a promissory note, and secured by Peoplefeeders' assets.
Petitioner's Income Tax Returns and Respondent's Audit
For each of its taxable years, Peoplefeeders, Square Pan,
and Square Pan’s subsidiaries filed consolidated corporate
Federal income tax returns. On petitioner’s 1992 consolidated
corporate Federal income tax return, the $3,751,930 difference
between Peoplefeeders’ total cash receipts and the total expenses
and loan payments paid out of the Intercompany bank account on
behalf of Peoplefeeders was reflected on the balance sheet
attached to the 1992 tax return as an intercompany receivable but
also as an adjustment or a reduction to Peoplefeeders' equity
investment in its subsidiaries.
On petitioner's 1992 consolidated corporate Federal income
tax return, Square Pan claimed a $3,751,930 bad debt deduction
relating to the alleged cancellation of the purported $3,751,930
debt obligation owed by Peoplefeeders to Square Pan.3 On its
3
For 1992, under sec. 1.1502-14(d), Income Tax Regs., bad
debt deductions were allowed upon cancellation of worthless debt
obligations between affiliated corporate entities even though
such entities filed consolidated Federal corporate income tax
returns. This regulation was generally effective for bad debt
(continued...)
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1990 and 1991 consolidated corporate Federal income tax returns,
petitioner claimed NOL carrybacks, and on its 1993 and 1994
consolidated corporate Federal income tax returns petitioner
claimed NOL carryforwards relating to the $3,751,930 bad debt
deduction claimed on the 1992 consolidated corporate Federal
income tax return.
Also, on the 1992 consolidated corporate Federal income tax
return, relying on the insolvency exception of
section 108(a)(1)(B) and Peoplefeeders’ alleged insolvency,
Peoplefeeders did not recognize any income relating to the
cancellation of the purported $3,751,930 debt obligation to
Square Pan. Further, on the 1992 consolidated corporate Federal
income tax return, Peoplefeeders took the position that, under
section 108(b), no reduction in any tax attributes (specifically
no reduction in the amount of the NOL that was claimed on the tax
return relating to the claimed $3,751,930 bad debt deduction) was
required on petitioner's tax return because the claimed bad debt
deduction and the related NOL did not “belong to” Peoplefeeders
(i.e., on the ground that the claimed bad debt deduction and the
related NOL constituted tax attributes not of Peoplefeeders, but
only of Square Pan).
3
(...continued)
deductions claimed prior to July 12, 1995, and was removed for
later years by amendments to the regulations as reflected in T.D.
8597, 1995-2 C.B. 147.
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Because petitioner under section 441 elected a "52-53 week"
taxable year, petitioner's consolidated corporate Federal income
tax returns for each of 1990 through 1994 accurately reflected
petitioner's taxable years beginning and ending on different
dates in late June and July (i.e., on the Sunday nearest the last
day of June of each year).
However, as set forth below, on the protest letter that
petitioner mailed to respondent, on the petition that petitioner
mailed to the Court, and on the 30-day letters and on the notice
of deficiency that respondent mailed to petitioner, the dates for
the ending of petitioner's 1990 through 1994 taxable years were
indicated as June 30 of each year. The actual last day of each
of petitioner's taxable years as reflected on petitioner's tax
returns for each year is also set forth in the schedule below:
Yearend Date Indicated On Petitioner's Respondent's
Taxable Tax Protest 30-Day Notice Of
Year Return Letter Petition Letter Deficiency
1990 July 1 June 30 June 30 June 30 June 30
1991 June 30 June 30 June 30 June 30 June 30
1992 June 28 June 30 June 30 June 30 June 30
1993 June 27 June 30 June 30 June 30 June 30
1994 July 3 June 30 June 30 June 30 June 30
On audit of petitioner's 1992 taxable year, respondent
disallowed petitioner's $3,751,930 claimed bad debt deduction and
the related claimed NOL carryback and carryforwards to 1990,
1991, 1993, and 1994. On September 12, 1997, with the trial
herein scheduled for October 27, 1997, petitioner, in a motion to
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dismiss for lack of jurisdiction, raised the issue that
respondent’s notice of deficiency incorrectly indicated ending
dates for petitioner’s taxable years, that the notice of
deficiency therefore was invalid, and that the Court lacks
jurisdiction over petitioner’s actual 1990 through 1994 taxable
years.
In making the above adjustments to petitioner’s consolidated
income and expenses for each year, respondent did not make any
adjustment, and respondent did not charge petitioner with any
item of income or adjust any expense item relating to the 2 or 4
days that were reflected in the notice of deficiency and that
were not part of petitioner’s 1990 through 1994 taxable years.
During respondent's audit of petitioner's 1990 through 1994
consolidated corporate Federal income tax returns, the accounting
firm of Arthur Andersen represented petitioner. Petitioner's
representatives from Arthur Andersen met with respondent,
discussed legal and factual issues, and later prepared and filed
the protest and the petition.
OPINION
Validity of Notice of Deficiency
Litigation in this Court requires as a jurisdictional
prerequisite a valid notice of deficiency. Sec. 6213(a). The
notice must indicate the taxable period involved or provide
sufficient information that the taxpayer reasonably could not be
misled as to the taxable period involved. Commissioner v. Forest
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Glen Creamery Co., 98 F.2d 968, 971 (7th Cir. 1938), revg. and
remanding 33 B.T.A. 564 (1935); Smith v. Commissioner, T.C. Memo.
1979-16.
Petitioner argues that because respondent's notice of
deficiency indicates that tax deficiencies were determined
against petitioner for taxable years ending on June 30 of each
year, when in fact petitioner's taxable years ended on dates
other than June 30, respondent's deficiency determinations should
be regarded as invalid. Further, petitioner argues that because
respondent never determined tax deficiencies for petitioner's
correct 1990 through 1994 taxable years, the Court has no
jurisdiction over any of such taxable years.4
Respondent argues that the notice of deficiency at issue in
this case was sufficiently accurate, did not mislead petitioner,
and adequately informed petitioner that the tax deficiencies
reflected therein related to petitioner's 1990 through 1994
taxable years.
We agree with respondent.
The June 30 date indicated in respondent's notice of
deficiency for the end of each of petitioner's 1990 through 1994
taxable years was an innocuous error and did not mislead
petitioner in any way. Petitioner’s representatives understood
4
For petitioner’s 1991 taxable year, which ended on June 30,
petitioner's jurisdictional argument is based on the allegation
that respondent's notice of deficiency for petitioner's 1991
taxable year implicitly treated petitioner's taxable year as
beginning on July 1, 1990, when in fact it began on July 2, 1990.
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that the references in the notice of deficiency to petitioner's
taxable years ending June 30 were to petitioner's actual taxable
years based on 52-to-53 week years that ended on the Sunday
nearest the last day of June of each year.
On petitioner's written protest letter and petition,
petitioner's representatives themselves indicated that
petitioner's taxable years ended on June 30. No evidence
indicates that petitioner's representatives were at any time
confused or misled over what taxable years were covered by
respondent's notice of deficiency. The record is clear that
petitioner's representatives were not misled as to whose and
which taxable years were in issue.
Not until just prior to the trial of this case in 1997 did
petitioner’s representatives allege that respondent's notice of
deficiency did not relate to petitioner's taxable years. Any
genuine lack of knowledge as to whose and which taxable years
were covered by respondent's notice of deficiency would have been
raised long before September 12, 1997. If petitioner’s
representatives genuinely believe respondent's notice of
deficiency did not determine tax deficiencies for any of
petitioner's taxable years, why were written protests filed on
behalf of petitioner in which the only challenges raised related
to the substance of the adjustments reflected in the notice of
deficiency?
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We also note that in making adjustments to petitioner’s
consolidated income and expenses, respondent, in the notice of
deficiency, did not make any income, expense, or other adjustment
relating to the 2 to 4 days that were reflected in respondent's
notice of deficiency but that technically were not part of
petitioner’s taxable years.
We conclude that respondent's notice of deficiency is valid
and determined deficiencies for petitioner's taxable years ending
on July 1, 1990, June 30, 1991, June 28, 1992, June 27, 1993, and
July 3, 1994, and that petitioner's tax liabilities for those
years are properly before the Court.
Bad Debt Deduction
Under section 166(a)(1), bad debt deductions are allowed for
loans that become worthless within the year. Under
section 1.166-1(c), Income Tax Regs., bad debt deductions are
limited to loans that arise from genuine debtor-creditor
relationships and that are based on valid and enforceable
obligations to pay fixed or determinable sums of money.
Generally a transfer of funds by a corporation to its
shareholders may be treated as a loan if, at the time of the
transfer, the parties intended that the shareholders repay the
corporation the amount of funds transferred. Crowley v.
Commissioner, 962 F.2d 1077, 1079 (1st Cir. 1992), affg. T.C.
Memo. 1990-636; Wiese v. Commissioner, 93 F.2d 921 (8th Cir.
1938), affg. 35 B.T.A. 701 (1937); Miele v. Commissioner, 56 T.C.
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556, 567 (1971), affd. without published opinion 474 F.2d 1338
(3d Cir. 1973).
Petitioner bears the burden of proving that the amounts in
question constitute loans. Rule 142(a); Welch v. Helvering, 290
U.S. 111, 115 (1933).
Courts typically determine whether the requisite intent to
repay was present by examining objective evidence of the parties'
intentions. See, e.g., Busch v. Commissioner, 728 F.2d 945, 948
(7th Cir. 1984), affg. T.C. Memo. 1983-98; Alterman Foods, Inc.
v. United States, 505 F.2d 873, 877 n.7 (5th Cir. 1974).
The following list of factors is often set forth in
analyzing whether transfers of funds between related corporations
should be treated as loans, as equity, or as dividends:
(1) Whether the transfers of funds are evidenced by written
promissory notes and are otherwise reflected on the taxpayer’s
books and records as loans; (2) the presence or absence of stated
maturity dates; (3) the source of payments; (4) the right to
enforce payments of principal and interest; (5) participation in
management; (6) a status equal to or inferior to that of regular
corporate creditors; (7) the intent of the parties; (8) "thin" or
adequate capitalization; (9) the identity of interest between
shareholders and creditors; (10) repayments on the purported
loans only out of profits; and (11) the ability of the purported
debtor to obtain loans from outside lending institutions.
Hardman v. United States, 827 F.2d 1409, 1411-1412 (9th Cir.
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1987); Bauer v. Commissioner, 748 F.2d 1365, 1368 (9th Cir.
1984), revg. T.C. Memo. 1983-120; A.R. Lantz Co. v. United
States, 424 F.2d 1330, 1333 (9th Cir. 1970); O.H. Kruse Grain &
Milling v. Commissioner, 279 F.2d 123, 125-126 (9th Cir. 1960),
affg. T.C. Memo. 1959-110.
Because the control element suggests the opportunity to
contrive a fictional debt, transfers of funds between related
corporations are subject to particular scrutiny. In re Uneco,
Inc., 532 F.2d 1204, 1207 (8th Cir. 1976). Transfers of funds
between closely held corporations and shareholders are often
characterized by informality, but in order to qualify for loan
treatment in such situations the transfer of large amounts of
funds generally should have some formal indicia of a loan. Lewis
v. Commissioner, T.C. Memo. 1985-563.
Where transfers of funds were made from a subsidiary
corporation to a parent corporation through a centralized
accounting system and where customary indicia of loans were not
present, the transfers were treated as constructive dividends and
not as loans. Alterman Foods, Inc. v. United States, supra.
Petitioner argues that the shareholders of Peoplefeeders
intended for Peoplefeeders to repay Square Pan the $3,751,930
difference between Peoplefeeders’ total cash receipts transferred
into the Intercompany bank account and the total expenses and
loan payments paid on behalf of Peoplefeeders out of the
Intercompany bank account and that the use of funds in the
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Intercompany bank account to pay Peoplefeeders' expenses and loan
payments should give rise to bona fide debt treatment of the
claimed $3,751,930.
Petitioner further argues that during its 1992 taxable year,
the purported $3,751,930 debt obligation owed by Peoplefeeders to
Square Pan became worthless, that for the year in issue bad debts
between members of consolidated groups of taxpayers were
deductible, and that petitioner is entitled to a bad debt
deduction of $3,751,930 for its 1992 taxable year.
Respondent argues that the payments out of the Intercompany
bank account of Peoplefeeders’ expenses and loan payments did not
have associated with them typical indicia of loans, and that the
evidence does not establish that it was intended for
Peoplefeeders to repay Square Pan any difference between cash
receipts transferred into the Intercompany bank account on behalf
of Peoplefeeders and expenses and loan payments paid out of the
Intercompany bank account on behalf of Peoplefeeders.
Respondent would treat that difference not as a genuine debt
obligation of Peoplefeeders to Square Pan but as a constructive
dividend from Square Pan to Peoplefeeders.
The purported $3,751,930 debt obligation of Peoplefeeders to
Square Pan was not evidenced by promissory notes or security
agreements. No maturity dates, interest, repayment terms, or
repayment amounts were agreed to. The transfers of cash receipts
from Peoplefeeders to the Intercompany bank account were not
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regarded or treated as “repayments” of any debt obligation, but
rather simply as a process of placing all of the cash receipts of
each of petitioner's related restaurants and corporate entities
into a single cash pot for purposes of cash management, credit
enhancement, and payment of bills. Such transfers into the
account were contingent on the amount of cash receipts received
from sales, a feature not typically associated with the payment
of genuine debt obligations.
In its brief, petitioner refers to the "ebb and flow" of
funds into and out of the Intercompany bank account. Such "ebb
and flow" in the transfer of cash between petitioner's related
entities reflected the mere management of funds and cash-flow and
an apparently efficient way for Peoplefeeders to move funds
between itself and related entities, not the establishment of
genuine debt obligations.
Because of the absence of fixed maturity dates and repayment
terms associated with the payment out of the Intercompany bank
account of Peoplefeeders’ expenses and loan payments, Square Pan
had no means of establishing Peoplefeeders' default and no basis
for seeking to enforce repayment of alleged debt principal or
payment of interest.
The evidence does not indicate that Square Pan ever
requested repayment from Peoplefeeders of the purported
$3,751,930 debt obligation, and in the minutes of Square Pan's
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May 4, 1992, board of directors' meeting, it is represented that
no repayment was ever made on this purported debt obligation.
The lack of a written promissory note, of collateral, of
security, of repayment terms, and of interest, among other
things, indicates that Peoplefeeders and its officers and
shareholders never intended for Peoplefeeders to have a fixed
repayment obligation to Square Pan or to the other related
subsidiaries of the $3,751,930 difference between cash receipts
transferred into the Intercompany bank account on behalf of
Peoplefeeders and expenses and loan payments paid out of the
Intercompany bank account on behalf of Peoplefeeders.
Square Pan's identity as a wholly owned subsidiary of
Peoplefeeders indicates that the relationship between the two
entities with regard to the $3,751,930 difference did not
constitute that of a creditor/debtor, but rather that it
constituted that of a subsidiary/parent, and that the $3,751,930
should not be treated as a bona fide debt obligation.
Between 1987 and 1992, with the operating assets of Square
Pan already secured in favor of the Motsenbocker and Commerce
Bank loans and with the failure in 1988 to raise funds through a
private placement memorandum, Peoplefeeders was not in a position
to repay the difference in funds paid out on its behalf from the
Intercompany bank account.
The significant relevant factors indicate that the
$3,751,930 in question should not be treated as a genuine debt
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obligation of Peoplefeeders. Petitioner is not entitled to the
claimed $3,751,930 bad debt deduction and the related NOL
carrybacks and carryforwards.
We note that respondent makes two alternative arguments --
one factual and the other legal. Respondent’s alternative
factual argument is that if the $3,751,930 is to be regarded as a
genuine debt obligation of Peoplefeeders to Square Pan, as
petitioner contends, in May of 1992 the full $3,751,930 principal
amount of that debt obligation would constitute a loan receivable
on the books of Square Pan and the value of the stock in Square
Pan that Peoplefeeders owned would reflect that $3,751,930
receivable, making Peoplefeeders no longer insolvent, and
requiring Peoplefeeders, under sections 61(a)(12) and 108(a), to
recognize $3,751,930 in discharge of indebtedness income.
Respondent’s alternative legal argument is that if the
$3,751,930 is to be regarded as a genuine debt obligation of
Peoplefeeders to Square Pan, if Peoplefeeders is to be regarded
as insolvent, and if, under the insolvency exception of
section 108(a)(1)(B), Peoplefeeders is to be allowed to exclude
from income the $3,751,930 discharge of indebtedness income,
petitioner’s consolidated group of taxpayers filing the 1992
corporate Federal income tax return would be required under
section 108(b) to reduce appropriate tax attributes (specifically
the amount of the NOL produced by the $3,751,930 bad debt
deduction) by the $3,751,930 amount of the excluded discharge of
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indebtedness income. Because of our holding on the threshold
issue, we need not decide respondent’s alternative arguments.
To reflect the foregoing,
An appropriate order will
be issued, and decision will
be entered under Rule 155.