9 T.C. 1082 (1947)

r
r

Advances from a corporation to a community organization, intended to secure the relocation of a factory in that community, constitute a debt if there is a reasonable expectation of repayment, even if the initial transfer of property is part of an inducement package.

r
r

Summary

r

McKay Products Corp. sought to deduct a bad debt and include certain property in its equity invested capital, stemming from its predecessor’s (Belle Knitting) dealings with Valley Industries, a community development corporation. Valley induced Belle to relocate by offering land and factory buildings, funded partly by employee pledges. Belle advanced funds to Valley when pledges fell short. The Tax Court held that Belle’s advances to Valley created a valid debt, deductible when Valley became insolvent. However, the court also ruled that Belle received the land and buildings in exchange for relocating, not as a gift, thus disallowing the use of Valley’s basis for depreciation and equity invested capital calculations.

r
r

Facts

r

Valley Industries, Inc. (Valley), a non-profit, sought to attract a manufacturing company to Sayre, Pennsylvania, to combat unemployment. They contacted Belle Knitting Corporation (Belle), offering land and a factory if Belle relocated. Valley funded the project through cash subscriptions and employee pledges authorizing payroll deductions. Valley purchased the land and constructed buildings for Belle, taking out a mortgage. Belle moved to Sayre in 1935. Valley experienced difficulties meeting its financial obligations due to slow pledge payments and borrowed significant sums from Belle.

r
r

Procedural History

r

The Commissioner of Internal Revenue determined deficiencies in McKay Products Corporation’s (successor to Belle) income tax, declared value excess profits tax, and excess profits tax for fiscal years 1940-1942. McKay Products Corp. petitioned the Tax Court contesting these deficiencies. The Tax Court addressed whether the advances created a debt, whether the property transfer was a gift, and related issues affecting loss carry-over and excess profits credit.

r
r

Issue(s)

r

1. Whether advances from Belle to Valley constituted a debt, and if so, whether the debt became worthless during the fiscal year ending July 31, 1940.r
2. Whether Belle acquired the land and buildings from Valley as a gift.r
3. Whether McKay Products Corp. is entitled to use Valley’s basis in the buildings for depreciation calculations.r
4. Whether McKay Products Corp. can include the cost of the land and buildings to Valley in its equity invested capital.

r
r

Holding

r

1. Yes, the advances created a debt because Valley requested the funds as loans, with a reasonable expectation of repayment, and Belle treated the advances as an asset.r
2. No, Belle did not receive the land and buildings as a gift because Belle provided consideration (relocation and payroll commitments) for the transfer.r
3. No, because Belle did not acquire the property as a gift, it cannot use Valley’s basis for depreciation.r
4. No, because Valley was a non-stockholder and the transfer was not a contribution to capital. It was part of an inducement to relocate.

r
r

Court’s Reasoning

r

The Tax Court reasoned that the advances from Belle to Valley were loans, not investments, based on Valley’s request for loans, the understanding of repayment, and Belle’s treatment of the advances as assets. The Court noted Valley specifically admitted the debt in an agreement. The Court found the debt worthless in 1940 because a Wage and Hour action prevented payroll deductions (Valley’s primary income source) rendering Valley insolvent. The court distinguished the case from situations where payments were considered investments to protect existing equity. Regarding the gift issue, the Court applied Detroit Edison Co. v. Commissioner, finding that Belle provided valuable consideration (relocating and agreeing to a payroll target) for the property transfer. The court emphasized that a