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provisions of section 7872 if such section were applied; and
(4) any nontax reasons for deciding to structure the transaction
as a below-market loan rather than a loan with interest at a rate
equal to or greater than the applicable Federal rate and a
payment by the lender to the borrower. Sec. 1.7872-5T(c)(3),
Temporary Income Tax Regs., 50 Fed. Reg. 33521 (Aug. 20, 1985);
see also H. Conf. Rept. 98-861, supra at 1020, 1984-3 C.B. at
274.
Petitioner contends that if section 7872 applies, the Tators
would be entitled to claim an interest expense deduction equal to
the interest they are deemed to have paid petitioner, and as a
result, the items of income and deduction offset each other.
Implicit in this contention is the assumption that the temporary
regulation permits the borrower's reduction in tax from the
interest deduction to offset the lender's increase in tax from
the interest income. Petitioner has misinterpreted the scope of
the exception. Because section 7872(h)(1)(C) and the temporary
regulation refer to the tax liability of the "lender or the
borrower", the factors must be applied separately to each
taxpayer.
The following example illustrates this point. In the case
of a below-market demand loan from a corporation to a
shareholder, the corporation is treated as transferring to the
shareholder, and the shareholder is treated as paying to the
corporation, an amount equal to the foregone interest. The
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