The Tax Court determined that an advance from a U.K.-based utility to its wholly owned partnership in connection with the partnership's acquisition of a U.S. utility company was a loan, not a capital contribution. Accordingly, the $932 million of payments made on loan notes was deductible by the partnership as interest.
Acknowledging that the advance NA General Partnership received from ScottishPower in an acquisition had “features … pointing to both debt and equity,” the Tax Court said that the substance of the transaction between the parent company and the Nevada corporation favored viewing the stock advance as loans that produced interest under Internal Revenue Code Sections 162 and 163(a). Whether an advance to a corporation is a capital contribution or a loan depends on the facts and circumstances.
In the Ninth Circuit, to which the instant case is appealable, the following factors are considered in determining whether an advance is debt or equity (11 Indicia of Indebtedness):
(1) The name given to the documents evidencing the indebtedness;
(2) The presence of a fixed maturity date;
(3) The source of the 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) Identity of interest between creditor and stockholder;
(10) Payment of interest only out of “dividend” money; and
(11) The corporation's ability to obtain loans from outside lending institutions. (Hardman v. U.S., (CA 9 1987) 60 AFTR 2d 87-5651)
“We did not rely on any single overriding factor. Rather, we find that the whole of this case is more reflective of the true relationship between the parties than the individual parts,” Judge Diane L. Kroupa said, applying the U.S. Court of Appeals for the Ninth Circuit's eleven-factor test to determine whether an advance is a debt or an equity.
Although ScottishPower was the sole shareholder involved in the transaction with NAGP, the court found all the other factors weighed toward a finding it was debt or that the factors were neutral.
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Read more at: Tax Times blog
