T.C. Memo. 1997-124
UNITED STATES TAX COURT
CHARLOTTE AIRCRAFT CORPORATION AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2582-96. Filed March 11, 1997.
G. Edward Hinshaw, Jr. and W. Curtis Elliott, Jr., for
petitioner.
Frank C. McClanahan III, for respondent.
MEMORANDUM OPINION
HAMBLEN, Judge: This matter is before the Court on
petitioner's motion for partial summary judgment. Unless
otherwise indicated, all section references are to the Internal
Revenue Code in effect for the taxable years at issue, and all
Rule references are to the Tax Court Rules of Practice and
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Procedure. In the notice of deficiency, respondent determined
deficiencies in petitioner's Federal income tax in the following
amounts:
Taxable Years
Ending Sept. 30 Deficiency
1987 $175,870
1988 17,909
1989 15,048
1990 187,808
1991 289,879
1992 15,402
The issue on which petitioner has moved for partial summary
judgment is whether petitioner is entitled to deductions for
interest pursuant to section 163 for taxable years ending
September 30, 1990, through September 30, 1992.
Pursuant to Rule 121, petitioner filed an affidavit with
exhibits in support of its motion for partial summary judgment.
Respondent filed a written response with an affidavit and
exhibits opposing petitioner's motion.
Rule 121(b) provides that a motion for summary judgment is
to be granted if “there is no genuine issue as to any material
fact and * * * a decision may be rendered as a matter of law.”
The disposition of a motion for summary judgment under Rule
121(b) is controlled by the following principles: (a) The moving
party must show the absence of dispute as to any material fact
and that a decision may be rendered as a matter of law; (b) the
factual materials and the inferences to be drawn from them must
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be viewed in the light most favorable to the party opposing the
motion; and (c) the party opposing the motion cannot rest upon
mere allegations or denials but must set forth specific facts
showing there is a genuine issue for trial. O'Neal v.
Commissioner, 102 T.C. 666, 674 (1994).
A motion for summary judgment will be granted if the Court
is satisfied that no real factual controversy is present so that
the remedy can serve "'its salutary purpose in avoiding a
useless, expensive and time consuming trial where there is no
genuine, material fact issue to be tried.'" Casanova Co. v.
Commissioner, 87 T.C. 214, 217 (1986) (quoting Lyons v. Board of
Educ., 523 F.2d 340, 347 (8th Cir. 1975)).
Solely for the purposes of disposing of petitioner's motion,
we set forth a summary of the facts relevant to our discussion.
Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520
(1992), affd. 17 F.3d 965 (7th Cir. 1994).
Charlotte Aircraft Corp. (CAC) is a corporation which was
duly formed under the laws of the State of North Carolina in or
about September 1953, for the purpose of buying and selling
transport category aircraft, aircraft engines, and aircraft
parts. In 1986, CAC formed Caldwell Aircraft Trading Co. (CATCO)
as a wholly owned subsidiary to buy, sell, lease, and broker
aircraft and aircraft engines.
CATCO contacted Security Pacific Equipment Leasing, Inc.
(SPELI), a subsidiary of Security Pacific Bank. SPELI had
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experience in the leasing and financing of fleets of aircraft.
CATCO and American Airlines (American) agreed that CATCO would
purchase from American 36 Boeing Model 727-023 aircraft, each
with 3 Pratt & Whitney JT8D-7B turbofan engines (36 aircraft),
and executed a letter of intent, dated April 6, 1990, and an
aircraft purchase agreement, dated June 8, 1990. The purchase
price per aircraft was $733,333.33, and the aggregate purchase
price was $26,400,000. At the time of the agreement, the fair
market value of an average Boeing 727-023 was $2 million, and the
cost of a "D" check, a very extensive routine maintenance check,
was $1.2 million.
CATCO executed a secured promissory note, dated June 27,
1990, with SPELI for the entire purchase price. The promissory
note provided for repayment of the loan, with interest at a rate
of 12 percent per annum, in 16 installments due on the following
dates:
Due Dates Principal Payment
9/1/92 $733,333.33
10/1/92 733,333.33
1/1/93 1,466,666.67
2/1/93 1,466,666.67
3/1/93 1,466,666.67
8/1/93 1,466,666.67
9/1/93 2,933,333.32
10/1/93 1,466,666.67
11/1/93 1,466,666.67
1/1/94 1,466,666.67
2/1/94 733,333.33
3/1/94 1,466,666.67
9/1/94 2,199,999.99
10/1/94 2,933,333.34
11/1/94 2,933,333.32
1/1/95 1,466,666.68
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As a condition to entering the transaction, SPELI required
CATCO and CAC to enter into a remarketing agreement, an
assignment agreement, and a lease with American. The remarketing
agreement provided that in the event that CATCO was unsuccessful
in selling the aircraft prior to delivery from American, SPELI
could require CATCO to transfer one or more aircraft to CAC for
the disassembly and sale of the aircraft and parts. SPELI also
required CAC to assume the debt attributable to such aircraft
when it acquired an aircraft to disassemble. Using its best
efforts, CAC agreed to sell the disassembled parts at not less
than 25 percent below CAC's estimated price for such a part. If
SPELI did not accept CAC's estimated prices, its only contractual
remedy was to terminate the remarketing agreement, leaving CAC
with no further liability. The remarketing agreement also
provided for the allocation of the proceeds between the parties
from the sale of any aircraft or parts. The remarketing
agreement first allocated the proceeds to the amounts due under
the promissory note, with any excess allocated 55 percent to
CATCO and 45 percent to SPELI. The assignment agreement required
CATCO to assign all of its rights under the aircraft purchase
agreement as security to SPELI.
The lease agreement provided for CATCO to lease the 36
aircraft to American for the remaining period of use in
accordance with American's "phase-out" schedule for each
aircraft. The lease contained a lease rate of $1 per month per
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aircraft. CATCO and CAC did not consider the economic realities
of the transaction to be those of a lease, and no provision was
made for the fair rental value of the aircraft, which was $60,000
per month per aircraft. CATCO and American entered the lease
agreement on June 8, 1990. American actually paid $1,000 in rent
for all 36 aircraft.
CATCO did not pay the first installment payment due
September 1, 1992. SPELI notified CATCO by telephone and by
letter that CATCO was in default and demanded payment of the
principal, interest, and late charges then due. CATCO continued
to look for potential buyers or lessees for the aircraft.
During that time, the U.S. Postal Service awarded a contract
to Postal Air, Inc. (Postal Air). CATCO and Postal Air entered
into a sales agreement in which Postal Air agreed to purchase 16
of the 36 aircraft from CATCO for a total purchase price of
$17,600,000. The day after CATCO signed the contract with Postal
Air, Emery Worldwide Airlines, Inc. (Emery), sought and was
granted a preliminary injunction preventing Postal Air and the
U.S. Postal Service from performing their contract.
The litigation between Emery and Postal Air was settled in
March 1993. As part of the settlement, Emery agreed to assist
Postal Air in meeting its obligations to CATCO. The settlement
agreement, dated March 28, 1993, required Emery to purchase eight
aircraft from CATCO for a total purchase price of $8,800,000 and
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to make an additional $3 million for CATCO's expenses (Emery
settlement).
On April 14, 1993, SPELI again notified CATCO of its failure
to make the installment payments. On April 15, 1993, SPELI
notified CATCO that it was declaring the note to be immediately
due and payable for the unpaid balance of principal, interest and
late charges in the amount of $36,505,715.15
On April 23, 1993, CATCO paid $11,318,575.52 to SPELI from
the proceeds of the settlement with Emery. A dispute arose
regarding whether this payment made CATCO current under the terms
of their agreement. On June 4, 1993, SPELI notified CATCO that
it would thereafter exercise CATCO's rights under the lease with
American.
CATCO failed to make the installment payment due September
1, 1993. On that same day, SPELI again demanded payment from
CATCO. On September 7, 1993, SPELI, CATCO, and CAC entered into
a settlement agreement in which CATCO conveyed the remaining
aircraft to SPELI in exchange for satisfaction of the balance of
payments due to SPELI. Under the agreement, SPELI permitted
CATCO to retain $500,000 of the proceeds from the prior
settlement agreement between CATCO and Emery.
On its consolidated Federal income tax returns for taxable
years ending September 30, 1989, through September 30, 1992,
respectively, CAC reported that CATCO's liabilities exceeded its
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assets by the following amounts: $885,712, $1,583,164,
$5,101,295, $9,045,475.
Petitioner deducted $763,869, $3,354,061, $3,667,803, and
$3,514,267 as interest in its consolidated Federal income tax
returns for taxable years ending September 30, 1990, through
September 30, 1993, respectively. In the notice of deficiency,
respondent disallowed these interest deductions in total.
For the reasons stated below, we agree with respondent that
there are genuine issues of material fact in the instant case and
consequently will deny petitioner's motion for partial summary
judgment.
Section 163 provides that there shall be allowed as a
deduction all interest paid or accrued within the taxable year on
indebtedness. In order to be deductible, interest must be paid
on genuine indebtedness. Knetsch v. United States, 364 U.S. 361
(1960).
The "all events" test governs whether an accrual of an
expense, including interest, is proper. See United States v.
General Dynamics Corp., 481 U.S. 239, 242 (1987). Section
461(h)(4) describes the “all events” test as follows:
All events test.--For purposes of this subsection, the
all events test is met with respect to any item if all
events have occurred which determine the fact of
liability and the amount of such liability can be
determined with reasonable accuracy.
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Section 461(h)(1) modifies the all events test, providing that
“the all events test shall not be treated as met any earlier than
when economic performance with respect to such item occurs”.
Economic performance with respect to interest occurs as the
interest cost economically accrues in accordance with the
principles of relevant provisions of the Code. Sec. 1.461-4(e),
Income Tax Regs.
Petitioner presents three basic arguments. First,
petitioner asserts that the substance of the disputed transaction
is that of a forward purchase contract and a loan. Second,
petitioner contends that the accrued interest due to SPELI was an
unconditional fixed obligation, which satisfied the all events
test for all the taxable years at issue. Third, petitioner
argues CATCO's intrinsic ability or inability to satisfy the loan
is irrelevant as to whether the accrued interest is deductible.
Respondent argues that the underlying substance of the
transaction is in dispute. Respondent further contends that a
reasonable inference may be drawn from all of the facts available
that the disputed transaction is a "best efforts" consignment
contract with CATCO serving as a sales agent for either SPELI or
American and that the interest represents a sharing of profits on
resale of the aircraft. Respondent alternatively argues that
even if petitioner is correct, the facts are not sufficiently
well developed to warrant a finding that the all events test is
satisfied. Respondent further argues CATCO's ability to pay
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interest is relevant both to determining the true substance of
the transaction and to determining whether petitioner was "at
risk" for purposes of section 465(b)(4).
We must first address the question of the economic substance
of the transaction. In support of her contention that the
economic substance of the transaction is in dispute, respondent
directs our attention to the fact that the remarketing agreement
provided for the sharing of profits between SPELI and petitioner
after the principal and interest payments have been made.
Respondent also points out that the remarketing and the
assignment agreements gave SPELI the ability to control CATCO's
possession and custody of the aircraft. Respondent finally
asserts that petitioner has failed to explain: (1) Why a
reasonable, prudent taxpayer would purchase with borrowed funds
$26,400,000 in revenue-producing assets, the aircraft, for which
the taxpayer is obligated to begin principal and interest
payments in approximately 2 years yet agree to realize only
$1,000 over the same period from a lease-back agreement; and (2)
why the settlement agreement between SPELI, CAC, and CATCO
permitted CATCO to retain $500,000 of the proceeds from the Emery
settlement even though CATCO was allegedly in default.
Upon examination of the pleadings, petitioner's motion for
partial summary judgment and the affidavits attached thereto, and
respondent's response and the affidavits attached thereto, we
believe there are genuine issues of material fact critical to the
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characterization of the transaction herein. Resolution of
whether a transaction is a loan depends in part on the intent of
the parties. Litton Bus. Sys. Inc. v. Commissioner, 61 T.C. 367,
377 (1973). The value of a trial with full opportunity to
observe the parties and their evidence is obvious. This is
especially so when the question of intent is present. Preece v.
Commissioner, 95 T.C. 594 (1990); Shiosaki v. Commissioner, 61
T.C. 861, 863-864 (1974). A conclusion as to a taxpayers' intent
should not be reached without the benefit of a trial in which the
demeanor of the witnesses can be observed and their credibility
can be weighed. Shiosaki v. Commissioner, supra, at 863-864.
In short, the issue is not ripe for summary adjudication.
Petitioner's claim is, in effect, that the documentation controls
the characterization. In order to grant petitioner's motion, we
would have to accept petitioner's interpretation of the documents
relating to the transaction, petitioner's understanding of the
transaction as the understanding of all the parties, and
petitioner's explanation of any apparent discrepancies. By
petitioner's reasoning, Gregory v. Helvering, 293 U.S. 465
(1935), should have been resolved on a motion for summary
judgment because the paperwork documented a reorganization. It
is the substance of the transaction and not the form which must
control the consequences for Federal tax purposes. University
Country Club, Inc. v. Commissioner, 64 T.C. 460, 471 (1975).
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The resolution of whether the substance of the transaction
at issue is a loan may obviate the necessity of deciding whether
the all events test is satisfied or whether petitioner's ability
to pay interest affects the availability of the deductions. For
these reasons, we conclude that petitioners' motion for partial
summary judgment must be denied.
An appropriate order will be issued.