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income is essentially equivalent to increased interest
expense."
Petitioner gives the following variation of the above
example to illustrate its position that taxpayers in the
same economic situation should be treated the same by
interpreting "interest" and "cost of borrowing", as used
in section 1.861-8(e)(2)(i), Income Tax Regs., to mean net
interest:
Suppose business A has an immediate need of
$800,000 and uncertain future needs, and a line
of credit of $1 million at 10 percent, and
immediately draws $800,000 on the line of credit.
The interest expenses on the $800,000 would be
$80,000, rather than $100,000. In contrast,
business B has a substantially identical need of
$800,000 immediately and uncertain future needs,
but has no line of credit. So, business B
obtains a loan from a bank for $1 million and
invests the surplus $200,000 in short-term
instruments bearing 10 percent. Although
business B's gross interest expense would be
$100,000, its cost of borrowing would be best
described as $80,000 ($100,000-$20,000).
Petitioner argues that in the context of section 1.861-
8(e)(2), Income Tax Regs., which is based upon the
"fungibility of money" and management's "flexibility as to
sources of funds", the two firms in the above example are
in the same economic situation and the cost of borrowing
incurred by both firms should be treated the same, as would
take place by recognizing interest as net interest expense.
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