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with all other purported debts in the employee leasing circles,
the interest is based upon purported loan transactions that were
not conducted at arm's length by independent parties. Moreover,
those debts are affected by "peculiar circumstances"--here,
Fred's unrestricted ability to set off and cancel loan
agreements--that indicate that the debts would not be paid. The
deduction of the interest is properly denied.41
IV. The Transactions at Issue Are Not Recognized for Purposes of
Claiming Deductions or Reporting Income
A. In Summary
In these cases, Fred designed circular programs of
offsetting obligations. For tax purposes, he treated these
obligations as commercially valid independent transactions. For
economic purposes, however, he treated them as self-canceling
transactions. The tax characteristics of a transaction must
reflect the economic reality of that transaction. We have found
that these transactions had neither economic substance nor a
profit objective. On the basis of the legal principles discussed
above, we hold that they had no tax effects. It follows that
respondent's disallowances of the claimed deductions are
sustained.
41Fred has also argued that some part of the payments of
"overrides" constituted the payment of interest by Machise. As
stated, see supra note 31, those overrides are illusory and are
not to be given effect for tax purposes.
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