Aristar, Inc. v. United States, 292-75.

• Decision Date: 20 April 1977
• Docket Number: No. 292-75.,292-75.
• Citation: 553 F.2d 644
• Parties: ARISTAR, INC. v. The UNITED STATES.
• Court: U.S. Claims Court

553 F.2d 644

ARISTAR, INC. v. The UNITED STATES.

No. 292-75.

United States Court of Claims.

April 20, 1977.

Richard J. Hiegel, New York City, atty. of record, for plaintiff. Alvin J. Goldman, New York City, of counsel.

Allan C. Lewis, Washington, D.C., with whom was Acting Asst. Atty. Gen. Myron C. Baum, Washington, D.C., for defendant. Theodore D. Peyser and Robert S. Watkins, Washington, D.C., of counsel.

Before COWEN, Senior Judge, and DAVIS and SKELTON, Judges.

ON PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT

SKELTON, Judge:

Plaintiff (taxpayer) in this case is a holding company with approximately 450 subsidiaries engaged in the consumer finance business in some 30 states. Plaintiff, itself, is not actively engaged in business and during the fiscal years in question (1964, 1965, and 1966) had only a minor amount of assets besides its advances to and equity investments in its subsidiaries. The consumer finance operations of the subsidiaries consisted primarily of making installment loans to individual borrowers in amounts ranging from $300 to $2,500.

Plaintiff operated by borrowing money and relending it to its subsidiaries. The subsidiaries were not acceptable credit risks on an individual basis; however, taxpayer was an acceptable risk and borrowed from various sources including banks. These borrowed funds were then loaned to the individual subsidiaries at a higher rate of interest under a credit agreement in which each subsidiary promised to pay its outstanding debt as of the date of execution and any sums borrowed from taxpayer in the future. Each subsidiary executed and carried on its balance sheet a note payable to its parent. In addition, each subsidiary filed a separate income tax return, and deducted thereon the interest paid to the parent corporation.

In relending funds to its subsidiaries, taxpayer followed a formula which charged interest on a ten percent if earned basis. If a subsidiary had sufficient net earnings for the current year, it paid interest at the ten percent rate. If a subsidiary had an accumulated deficit and a current loss (which reflected an interest expense of ten percent of its average daily balance of indebtedness), it paid no interest if the current loss was in excess of the ten percent interest expense figure. (In other words, a subsidiary's interest payments were reduced according to its operating losses.) However, if the ten percent interest figure was greater than the current loss, the subsidiary paid interest equal to the difference between the ten percent interest figure and the current loss. The adjustment in this latter situation could reduce the loss to zero. For example, if a subsidiary had income of $10 and expenses of $18 including $6 of interest, its current loss would be $8 ($10-$18) and it would pay no interest. For tax purposes, the subsidiary would report $10 of income and $12 of deductions (because the $6 of interest was not paid to the parent), or a loss of $2 for the year. If a subsidiary had income of $10 and expenses of $12, including $6 of interest, its current loss would be $2 ($10-$12), and it would pay interest of $4 ($6-$2), the difference between the ten percent interest figure and the current loss. Thus, the subsidiary would report for tax purposes the $10 of income and $10 of deductions (which includes $4 of interest) or a zero gain for the year. During the years in dispute, plaintiff was able to obtain an interest rate of 5.3 percent to 5.5 percent on its commercial borrowing, and charged an effective overall rate to its subsidiaries of between 9.1 percent and 9.3 percent.

On audit, the Commissioner of Internal Revenue made no adjustment to the taxpayer's interest income with respect to those subsidiaries which paid four percent or more interest. However, additional interest income was allocated to taxpayer under Section 482 of the Internal Revenue Code and the regulations thereunder from those subsidiaries which paid no interest or interest less than four percent. The additional interest income from each subsidiary was the difference between five percent interest and the amount of interest actually paid by the subsidiary. This was in accordance with regulations § 1.482-2(a)(2)(iii)(B), which provides that if a creditor "was not regularly engaged in the business of making loans or advances * * * to unrelated parties, the arm's length rate of interest * * * shall be * * * five per cent per annum simple interest if no interest was charged or if the rate of interest charged was less than 4, or in excess of 6, per cent per annum simple interest." The implications of the term "arm's length...