67 T.C. 1060 (1977), 9192-74, Crown v. C.I.R.

Docket Nº:9192-74.
Citation:67 T.C. 1060
Opinion Judge:DAWSON, Chief Judge:
Attorney:Byron S. Miller, for the petitioner. Seymour I. Sherman, for the respondent.
Judge Panel:DRENNEN, QUEALY, and HALL, JJ., did not participate in the consideration and disposition of this case. SIMPSON, J., dissenting:
Case Date:March 31, 1977
Court:United States Tax Court

Page 1060

67 T.C. 1060 (1977)




No. 9192-74.

United States Tax Court

March 31, 1977

Petitioner was a one-third partner in Areljay Co., Not Incorporated. Areljay made substantial non-interest-bearing demand or open account loans to 24 trusts established for various relatives, most of whom were children. Held, petitioner is not subject to the gift tax on his proportionate share of the partnership's outstanding loans because the making of non-interest-bearing loans under these circumstances is not a taxable event.

Byron S. Miller, for the petitioner.

Seymour I. Sherman, for the respondent.


DAWSON, Chief Judge:

Respondent determined a deficiency of $46,084.54 in petitioner's Federal gift tax for the year 1967.

The issue presented for decision is whether interest-free loans to relatives of the lender (or trusts for the benefit of such relatives) give rise to taxable gifts from the lender to the borrowers to the extent of the value of the use of the funds loaned; and, if so, what is the proper measure of the amount of such gifts.

All of the facts were stipulated by the parties. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. The pertinent facts are summarized below.

Petitioner was a legal resident of Wilmette, Ill., when he filed his petition herein. He filed his Federal gift tax return for the calendar year 1967 with the District Director of Internal Revenue at Chicago, Ill. Petitioner and his two brothers, Robert Crown (now deceased) and John J. Crown, were equal partners in Areljay Co., Not Incorporated (Areljay), an Illinois general partnership formed in 1944.

In 1967 the Areljay partners had a total of 15 children, separate trusts for 12 of whom are involved herein. Harry N. Wyatt was the trustee of all the trusts, and he was also the trustee of a trust for a first cousin of the Areljay partners and of separate trusts for 11 children of first cousins of the Areljay partners.

Page 1061

As of January 1, 1967, Areljay had loans receivable outstanding from 13 of the foregoing trusts in the aggregate amount of $2,262,574, most of which were represented by non-interest-bearing demand notes. The other 11 trusts were not indebted to Areljay at that date. On January 3, 1967, Areljay made separate open account loans, aggregating $15,960,000, to all 24 trusts to enable each trust to acquire an interest in a partnership known as Henry Crown & Co. (Not Incorporated). During the balance of 1967 Areljay made other miscellaneous loans to some of these trusts and received some repayments on account, so that as of December 31, 1967, loans represented by demand notes totaled $2,073,649 and loans on open account totaled $15,956,375.

All of the aforementioned loans were recorded in the books of Areljay and the respective borrowing trusts, and were evidenced by either demand notes or open accounts. Although none of the demand notes made any provision for interest before demand, all provided for interest at 6 percent per annum after demand. None of the open account loans had a provision with respect to interest. At no time during 1967 did any of the trusts pay, nor were any requested to pay, any amount of interest in respect of any of the loans. During 1967 the market prime rate of interest ranged between 5 1/2 percent and 6 percent per annum, averaging 5.63 percent.

At all pertinent times, Areljay, its partners, and all of the trusts have operated on the cash basis method of accounting, and have used the calendar year as their respective taxable year.

In his notice of deficiency pertaining to petitioner's gift tax return for 1967, respondent determined that each interest-free loan made by the Areljay partnership to the various trusts constituted a gift of the value of the use of the money loaned. Respondent determined a reasonable rate of interest to be 6 percent per annum, and computed the amount of interest that parties bargaining at arm's length would have charged by applying that rate on a daily basis with respect to the outstanding balances of the amounts due both on the demand notes and the open-account loans. The total amount of interest computed in this manner was $1,086,407.75. One-third of this total amount, or $362,135.92, was deemed by

Page 1062

respondent to have been a gift by petitioner, as a one-third owner of Areljay.

The issue presented here is one of first impression in this Court. Respondent seeks to apply the gift tax to the value of interest-free use of loaned funds. In 1973, the year before the notice of deficiency was sent to petitioner, respondent issued Rev. Rul. 73-61, 1973-1 C.B. 408, setting forth his position that:

The right to use property, in this case money, is itself an interest in property, the transfer of which is a gift within the purview of section 2501 of the Code unless full and adequate consideration in money or money's worth is received. The tax * * * would be imposed on the value of the right to use the money. * * *

The ruling states that in the case of a term loan, the present value of the interest-free use of the money for the entire term of the loan is to be determined actuarially and deemed to be a completed gift as of the date the loan is made; and, in the case of a demand loan, the value of the use of the money must be calculated on a quarterly basis and deemed a gift during each calendar quarter in which such interest-free loan is actually outstanding.

The revenue ruling then makes reference to, and specifically refuses to follow, the decision in Johnson v. United States, 254 F.Supp. 73 (N.D. Tex. 1966), the only case in which this specific issue has previously been litigated. In the Johnson case, the District Court squarely held that interest-free loans to family members, repayable upon demand, did not constitute gifts of the value of the use of the money. For the reasons stated hereinafter, we think the decision reached in Johnson v. United States, supra, was correct, and that...

To continue reading