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Rowes wanted to characterize the transfers as loans because the
Rowes believed that additional equity in petitioner would
increase their estate tax burden and reduce the amount of
property received by their heirs. The transfers were unsecured,
undocumented, and petitioner agreed to pay a 10-percent return on
all transfers from 1987 through 2000. During this 14-year
period, the prime rate fluctuated between 6 and 9.5 percent for
almost 12 years. Petitioner made monthly payments to the Rowes
calculated at 10 percent of the transferred funds (i.e.,
reflected in the “notes payable - stockholders” account balance).
The monthly payments represented an investment return and were
not repayments of the transfers. Petitioner’s partial
repayments, however, were sporadic, paid on demand, based on the
Rowes’ financial needs, and not subject to set or predetermined
due dates. From 1987 to 2000, the Rowes’ transfers were not
repaid in full.
Tennessee residents, pursuant to Tenn. Code Ann. sec. 67-2-
101 (2000), are taxed on the receipt of dividends and interest.
Promissory notes that mature in 6 months or less are, pursuant to
Tenn. Code Ann. sec. 67-2-101(1)(B)(i), exempt. To avoid the tax
on interest and dividends, petitioner and the Rowes took the
position that the transfers were demand notes. Petitioner,
however, reported the transfers as long-term liabilities, on its
financial statements, to avoid violating loan agreements with
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