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Cap Corp.’s 1995 financial statement reflects total assets
of $755,731 and total liabilities of more than $5 million. The
1996 financial statement reflects total assets of $150,958 and
total liabilities of almost $4.6 million.
Respondent contends that from January 1, 1995, through
December 1, 1996, Cap Corp. was thinly capitalized. Respondent
points out that Cap Corp.’s financial statements reflect a debt-
to-equity ratio of at least 5 to 1 from 1995 through December 2,
1996. Following the December 2, 1996, debt conversion of $2.259
million, Cap Corp. remained insolvent and unable to benefit from
CKS’s future profitability.
Petitioner argues that thin capitalization is not decisive
by itself and that a loan to a seemingly insolvent entity may
nonetheless be treated as debt if repayment was reasonably
expected. Petitioner acknowledges, however, that Cap Corp.
lacked tangible assets to serve as security or a repayment source
for the advances.
We agree with respondent that up until December 2, 1996, Cap
Corp. was thinly capitalized and that, even after the December 2,
1996, debt conversion, Cap Corp.’s earnings base was insufficient
to meet its obligations to third-party creditors and petitioner
under the December 1, 1996, promissory note. As discussed above,
the December 1, 1996, promissory note was reduced to $500,000 as
of November 30, 1996, and petitioner continued to make advances
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