Indmar Products Co., Inc. - Page 7

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          stockholders while FTB loans remained outstanding.  On November             
          21, 1995, when the prime rate was 8.5 percent, petitioner                   
          borrowed $650,000 from FTB, at 7.5 percent, to pay Mr. Rowe.  In            
          1997, petitioner and FTB executed a promissory note for                     
          $1,000,000 that was modified in 1998.  The interest rate on the             
          note was below the prime rate.  At the time the petition was                
          filed, petitioner’s principal place of business was located in              
          Millington, Tennessee.                                                      
               Respondent contends that petitioner’s interest expense                 
          deductions relating to payments made to the Rowes should be                 
          disallowed because the transfers were capital investments and not           
          loans.  Petitioner contends that the transfers were loans.                  
               Taxpayers are entitled to a deduction for payments made on             
          bona fide indebtedness that relates to an existing,                         
          unconditional, and legal obligation to repay.  Sec. 163(a);                 
          Burrill v. Commissioner, 93 T.C. 643 (1989).  Petitioner bears              
          the burden of proving that the transfers are debt and not                   
          equity.3  Rule 142(a); Smith v. Commissioner, 370 F.2d 178, 180             
          (6th Cir. 1966), affg. T.C. Memo. 1964-278.                                 
               Transfers between related parties are examined with special            
          scrutiny when taxpayers contend that such transfers are loans.              

               3 Sec. 7491(a) is inapplicable because petitioner does not             
          meet the net worth requirements of sec. 7430(c)(4)(A)(ii), which            
          are cross-referenced in sec. 7491(a)(2)(C).                                 

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