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Certain criteria used to determine if a transfer is a sale or equity contribution include: Was the capital and credit structure of the new corporation realistic? What was the business purpose, if any, of organizing the new corporation? Were the noteholders the actual promoters and entrepreneurs of the new adventure? Did the noteholders bear the principal risks of loss attendant upon the adventure? Were payments of principal and interest on the notes subordinated to dividends and to the claims of creditors? Did the noteholders have substantial control over the business operations; and, if so, was such control reserved to them, as an integral part of the plan under which the notes were issued? Was the price of the properties, for which the notes were issued disproportionate to the fair market value of such properties? Did the noteholders, when default of the notes occurred, attempt to enforce the obligations?
The petitioners, Burr Oaks Corporation, A. Aaron Elkind and Rosella Elkind, Harold A. Watkins and Fannie G. Watkins, Maurice Ritz and Esther Leah Ritz, instituted these proceedings in the Tax Court to contest deficiencies in income taxes determined against them. Mrs. Elkind, Mrs. Watkins and Mrs. Ritz are in these cases only because joint income tax returns were filed. The cases were consolidated. The opinion of the Tax Court is reported at 43 T.C. 635, No. 51. The Tax Court held that the transfer of certain land by the petitioners A. Aaron Elkind, Harold A. Watkins and Maurice Ritz (hereinafter called "the individual appellants") to the corporate appellant represented a contribution to capital and not a sale. Accordingly, the Tax Court determined a deficiency against the corporate appellant for fiscal years ended September 30, 1958, 1959 and 1960. The Tax Court found deficiencies for one of the individual appellants, but also found an overpayment by all three of the individual appellants for 1959. The individual appellants have taken this appeal because of their concern as to adverse effect on future taxable years.
Did the transfer represent an equity contribution?
The appellate court affirmed the order, holding that the transfer represented an equity contribution. The court held that the payment to appellant individuals for the transfer was dependent on the success of Burr Oaks, an untried undercapitalized business with uncertain prospects. Further, it found that appellant individuals, while not shareholders, controlled Burr Oaks’ affairs. The court fixed Burr Oaks’ basis for the property as the carry-over basis from appellant individuals pursuant to 11 U.S.C.S. § 362(a)(1).