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Of critical importance in determining whether financial input is debt or equity is whether or not the money is expended for capital assets.
The Plantation Patterns, Incorporated became a new company after the old one entered bankruptcy liquidation. The Plantation filed income tax returns, on the accrual basis, for its taxable years ended September 30, 1963 through September 30, 1965, with the office of the District Director of Internal Revenue, Birmingham, Alabama. The individual taxpayers also filed their joint income tax return for their taxable year ended December 31, 1963, with the Birmingham District Director at Birmingham. The Plantation was assessed tax deficiencies. The Tax Court found that all of the actions of the shareholders of the company and individual petitioners were part of a single transaction to enable the company to purchase the bankrupt business and that, applying relevant factors with respect to debt-equity situations to the facts, one being thin capitalization, the guaranteed debt had to be treated as an indirect contribution to the company's capital by individuals; therefore, the company was not entitled to deductions claimed under 26 U.S.C.S. § 163 for interest on serial notes. Also, the individuals were taxable under 26 U.S.C.S. §§ 301 and 316 with the principal and interest payments on the guaranteed notes. The taxpayers appealed.
Did the Tax Court err in finding tax deficiencies against the taxpayers?
The Court affirmed the judgment because the transaction was a loan, an individual's financial skills were properly excluded from computing company's debt-equity ratio, and the lower court's remaining rulings were not clearly erroneous.