- 43 -
clarifies the principles of the listed rulings in a manner which
indicates that a circular cash-flow would not be proscribed. If
the parent may contribute its own stock as the equity capital, we
see no principled reason why the parent’s debt could not be
substituted for this purpose, particularly given that Rev. Rul.
69-377, supra, allowed a finance subsidiary’s capital to be
invested in an affiliate’s stock or debt. If a finance
subsidiary may be capitalized with parent debt, then it would
follow that a finance subsidiary receiving a cash capital
contribution from the parent could re-lend that cash to the
parent for the parent’s note, resulting in a circular cash-flow.
A circular cash-flow is therefore not inconsistent with, or
implicitly prohibited by, the principles of the listed rulings.21
Respondent’s argument that the capitalization of Finance should
be disregarded for purposes of DEFRA section 127(g)(3) because it
involved a circular cash-flow is unavailing.22 Finance’s
21 We note in this regard that the Commissioner reached the
same conclusion in several private letter rulings issued during
the period when the listed rulings were effective, where he held
that a cash capital contribution to a finance subsidiary could be
lent back to the parent without adversely affecting the
subsidiary’s equity capital for purposes of the 5-to-l
debt/equity ratio.
22 We reach the same conclusion regarding an alternative
argument of respondent’s to the effect that Finance’s
capitalization with the HGI notes should be disregarded because
the notes were unenforceable because of a lack of consideration.
This argument is merely a different iteration of the contention
that the circular cash-flow should cause Finance’s capitalization
(continued...)
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