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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.
OPINION
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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