ABC Bev. Corp. v. Comm'r , 92 T.C.M. 268 ( 2006 )

T.C. Memo. 2006-195
UNITED STATES TAX COURT
ABC BEVERAGE CORP., f.k.a. BEVERAGE AMERICA, INC.,
Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14868-02. Filed September 11, 2006.
Ronald G. Dewaard and Kaplin S. Jones, for petitioner.
Lawrence C. Letkewicz and David Flassing, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KROUPA, Judge: Respondent determined a $5,169,946
deficiency in petitioner’s Federal income tax for 1995 by denying
petitioner a $10 million partial bad debt deduction under section
- 2 -
166.1 After concessions,2 we must determine whether $10 million
of an $18 million debt became worthless in 1995.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
incorporated by this reference. Petitioner’s principal place of
business was Northlake, Illinois, at the time it filed the
petition.
The issue in this case arose as a management group attempted
to respond quickly to a changing business environment in the
bottling industry. As background, we explain the bottling
industry in general and the economic environment in which it
existed.
Bottling Industry
The soft drink bottling business around 1986 consisted of
the "big three." There were two well-known titans, Coke and
Pepsi, and a third quasi-independent network that encompassed all
other beverages. Independent beverage labels at that time
included drinks like Squirt, Dr. Pepper, 7-Up, Burns, and certain
"new age" drinks. The independent bottling network was also
1
All section references are to the Internal Revenue Code in
effect for the year at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
2
The parties have resolved all other issues raised in the
deficiency notice and the petition.
- 3 -
two-tiered in the sense that there were independent concentrate
makers and independent bottling facilities, each usually owned
separately yet dependent upon one another.
Economic Landscape
The bottling industry began to realign fundamentally around
1986 as Coke and Pepsi vertically integrated their bottling
businesses by buying their bottling facilities. Coke and Pepsi
could then produce, bottle, and distribute their own beverages
without independent bottlers.
This marked an important departure from the bottling
business of the past when bottling facilities could contract with
Coke or Pepsi to exclusively bottle and distribute their drinks
in a given geographic region. Independent bottling companies
lost that resource after Coke and Pepsi vertically integrated and
pressured the independent bottling companies to sell their
franchise rights to Coke or Pepsi.
In addition, 1986 was the heyday of the leveraged buyout
(LBO) era, in which investors were scouring the country for high
cashflow industries. The bottling industry with its fairly high
cashflow business was an attractive industry for an LBO.
Bottlers
One LBO opportunity in the bottling industry arose when
Philip Morris, Inc. chose to exit the soft drink bottling
business. The managers of this bottling business (the management
- 4 -
group) saw an opportunity to buy the business they had been
managing in an LBO. Although several other competing groups also
sought to buy the bottling business, the management group
assembled its financing sooner than the competitors and purchased
the company, Mid-Continent Bottlers, Inc. (Bottlers), a
subsidiary of Philip Morris, Inc., in 1986.
Bottlers was an independent soft drink bottling business in
the Midwest, operating primarily in Iowa, Nebraska, and portions
of Illinois, Kansas, and Missouri. Bottlers bottled mainly for
Cadbury. In fact, Cadbury was about 90 percent of Bottlers’
business. Cadbury maintained considerable control over Bottlers’
ability to transfer its franchise agreements to bottle for
Cadbury to other parties. These franchise agreements were key to
Bottlers’ business and among its most valuable assets.
Financing the Leveraged Buyout
The management group used an LBO to finance the purchase of
Bottlers from Philip Morris, Inc. Once the LBO was completed,
the management group, consisting of seven executives, owned less
than 40 percent of Bottlers.
The financing for the transaction took several forms. Not
all of the financing was on the most advantageous terms because
of certain business exigencies. For example, the management
group was anxious to acquire an ownership interest in Bottlers
rather than remain employees, and the management group was under
- 5 -
a tight timetable to complete their financing before competing
bidders could.
The Lease
One portion of the LBO financing was both a capital
contribution and asset financing from a sale-leaseback entity
called Corporate Property Associates 7 (CPA7). In this LBO
financing arrangement, CPA7 agreed to purchase the bottling
facilities Bottlers used to bottle its products (located in seven
locations in three States) and lease them to Bottlers on terms
favorable to CPA7. The lease had a 25-year term and contained
significant rent escalators. As a result, the lease offered a
premium to CPA7 because it would eventually rent at premium or
above-market rates as the rent escalated.
Because of the onerous lease provisions, the management
group knew Bottlers eventually had to renegotiate or buy out the
lease to avoid the rent escalators. Six years after the LBO, the
management group was considering buying the bottling facilities
from CPA7 to avoid further rent escalators, but the prospect of
Bottlers owning the bottling facilities posed three problems.
First, the management group wanted Bottlers to be salable to
Coke or Pepsi. Neither Coke nor Pepsi, however, would buy
Bottlers if it owned bottling facilities because Coke and Pepsi
already had bottling facilities.
- 6 -
Second, Cadbury had the contractual right to disapprove any
sale of Bottlers’ franchise rights. Cadbury insisted the
franchise rights be sold only to Coke or Pepsi so that Cadbury
products would be placed in Coke or Pepsi vending machines.
Third, buying the bottling facilities would cause friction
with Bottlers’ limited partners. Around 1989, Bottlers replaced
some of its original LBO financing by selling equity interests in
a limited partnership to approximately 50 independent investors.
The limited partners and the management group had different views
on how to run Bottlers. The limited partners wanted an early
high return, while the management group emphasized long-term
growth. These divergent views led to many heated communications,
threats, and a proxy fight.
The management group decided, given these internal and
external business reasons, that it was best to lease the
facilities rather than own them outright. The management group
wanted a third party to buy the bottling facilities from CPA7,
assume the lease, and then renegotiate the lease to remove the
rent escalators.
A Buyer
Bottlers identified G&K Properties, Inc. (G&K) as a
potential buyer that would lease the facilities to Bottlers on
renegotiated (and more favorable) terms. G&K was an unrelated
Iowa real estate development company with which Bottlers had
- 7 -
previously worked. G&K was interested in expanding its real
estate holdings by buying the facilities. G&K and Bottlers
drafted a letter of intent formalizing G&K’s intent to purchase
the bottling facilities for approximately $18 million. G&K had
identified a life insurance company in Davenport, Iowa, as a
potential source of financing but needed time to work out the
details.
While G&K was obtaining the necessary financing, the
management group worked on avoiding the rent escalators in the
CPA7 lease and approached CPA7 regarding a sale. Initially CPA7
requested $22 million for the bottling facilities, but Bottlers
and CPA7 ultimately agreed on a $17.8 million price. To lock in
the $17.8 million price tag and avoid further rent escalators,
the management group found a short-term, interim solution to give
G&K the time it needed to obtain the financing. The management
group decided to create a third-party company to own the assets
temporarily until G&K’s financing came through.
Neither Bottlers nor CPA7 appraised the underlying
facilities during their negotiations. Instead, the lease
payments drove the price, which was based on the present value of
the future stream of payments. Bottlers recognized that this
price included a premium over fair market value because of the
unfavorable lease terms. The management group knew it needed to
- 8 -
act quickly to complete the deal and to avoid further escalations
of rent.
The Purchase
The management group formed an unrelated entity called
Mid-Con Properties, Inc. (Properties) as a short-term solution to
buy the bottling facilities from CPA7 in 1994. The management
group owned 100 percent of Properties.
To fund the purchase, Bottlers obtained a loan from one of
its original LBO investors, the Prudential Life Insurance Company
(Prudential). Bottlers lent the loan proceeds to Properties (the
Properties loan) on the same terms Bottlers had with Prudential.
Properties then used the proceeds to buy the facilities from CPA7
and assumed the lease. The bottling facilities collateralized
the loan from Bottlers.
Properties and Bottlers amended the lease to remove the rent
escalators and implemented a rent payment structure equaling the
amounts due on the Properties loan. Accordingly, Bottlers
periodically paid Properties rent payments, and Properties paid
Bottlers loan payments at the same times. Bottlers’ rent
payments equaled Properties’ loan payments. No cash needed to be
transferred between Properties and Bottlers for them to satisfy
their respective loan and lease obligations to each other. This
zero net cashflow effect was an essential part of the deal to
satisfy Prudential that the payments Bottlers made to Properties
- 9 -
(of rent) would return to Bottlers when Properties made payments
to Bottlers (of loan repayment), and Properties could not divert
any cash to other uses. Prudential approved the loan on these
terms.
Petitioner and respondent stipulated that Properties’
purchase of the bottling facilities from CPA7 was not motivated
in any significant way by tax considerations and that Bottlers
and Properties were not related parties under the Code.
The management group had a reasonable expectation that G&K
would acquire the necessary financing to purchase the facilities
to satisfy the loan or that the loan would be repaid through
rental income. They expected that once the transaction with G&K
closed and G&K paid the $18 million purchase price to Properties,
Properties would pay Bottlers the balance due on the Properties
loan, and Bottlers would pay Prudential the balance due on its
loan. The parties intended that Properties would be liquidated
once G&K bought the facilities.
The management group continued working with G&K through the
end of 1994, when the first full payment of principal and
interest on the Properties loan was due. Given the short-term
solution that creating Properties was intended to be, the
management group decided Bottlers should not make full lease
payments to Properties. Bottlers paid only enough so that
Properties could pay interest on the Properties loan, not the
- 10 -
principal. Properties’ bookkeeping entries reflected Bottlers’
failure to pay the full amount of rent and Properties’
corresponding failure to repay principal on the loan.
The management group had not anticipated that it would take
G&K so long to obtain the financing. Given this delay, the
management group decided not to pay the full amount of rent for
two reasons. First, they were concerned that paying the portion
of the rent corresponding to the principal Properties owed would
enable Properties, which was owned by the management group, to
build equity in the facilities, which might alarm the limited
partners. Second, the important net zero cashflow effect of the
transaction would be destroyed if Bottlers paid Properties the
rent corresponding to the principal. Properties would have an
interest deduction for the portion of the rent corresponding to
the interest but no deduction for the portion of the rent
corresponding to the principal. Properties would therefore have
net income and would be exposed to income tax.
Buyer Financing Collapses
Unexpectedly, G&K’s purchase of the bottling facilities fell
through in early 1995. The insurance company G&K expected to
provide the bulk of the financing was unable to complete the
deal. Bottlers searched fruitlessly for alternate buyers.
- 11 -
Brooks Beverage Transaction
Brooks Beverage approached Bottlers regarding a business
combination shortly after the G&K financing fell through. Brooks
Beverage was interested in combining with Bottlers for several
reasons. Brooks Beverage wanted to consolidate its position as a
large independent bottler. It also preferred that Bottlers not
be sold piecemeal to Coke or Pepsi, which might fragment the
independent bottling network further. In addition, unbeknownst
to Bottlers, Cadbury had already approved Brooks Beverage’s
proposed combination with Bottlers. Combining the companies made
logistical sense as well because Bottlers served a different
geographic region than Brooks Beverage, and Brooks Beverage,
therefore, could reach a larger geographic region by combining
with Bottlers. Moreover, Bottlers was the third largest
independent bottling company in the country, and Brooks Beverage
was the second. The two companies, when combined, would offer
synergies and economies of scale and would help fortify the
entire independent bottling industry. Bottlers agreed to the
proposed transaction.
Brooks Beverage acquired all the stock of Bottlers for $48.5
million in 1995. The resulting new company was called Beverage
America, Inc. (BevAm) (now ABC Beverage Corp.). The management
group received stock in BevAm and accepted executive positions
with BevAm in the transaction.
- 12 -
Post-Combination
After the entities combined, BevAm conducted appraisals of
all the bottling facilities. The facilities were appraised for
approximately $8 million based on their fee-simple (not
lease-fee) value. BevAm’s accounting firm advised BevAm that it
had a potential worthless debt because the collateral securing
the debt was worth less than the debt. In addition, the
accounting firm noted that Properties had not been making full
loan payments to Bottlers (because Bottlers had not been making
full rent payments to Properties), and Properties was therefore
in default.
In addition, BevAm preferred to own the facilities outright
for three reasons. First, BevAm wanted the flexibility to make
certain changes to the facilities without lease restrictions.
Second, BevAm did not want certain members of the management
group owning equity in Properties while others did not. Third,
the rationale for not owning the bottling facilities (i.e.,
keeping Bottlers salable to Coke or Pepsi) no longer existed
after the BevAm transaction. For these reasons, BevAm declared
Properties in default, seized the bottling facilities and some
cash in exchange for releasing Properties from the loan, and
deducted the difference between the value of the assets ($8
million) and the unpaid principal on the Properties loan ($18
million) on its consolidated return for 1995.
- 13 -
Respondent issued petitioner a deficiency notice denying the
$10 million partial bad debt deduction for 1995. Petitioner
timely filed a petition.
OPINION
The issue in this case arose in the context of a fast-paced
and changing business environment. While the management group
made the best business decisions under the circumstances at the
time, exigent circumstances beyond the management group’s control
caused the management group not to be able to achieve their
goals. We are now called upon, more than 10 years later, to
decide the tax consequences of these business decisions.
The parties stipulated that the parties were not related
under the Code and that there was no tax motivation underlying
the transaction between Bottlers and Properties. The parties
also stipulated that Bottlers had a reasonable expectation that
the Properties loan would be repaid. Respondent does not
challenge the substance of the transaction.
The issue before us, put simply, is whether petitioner is
entitled to deduct a portion of the debt, $10 million, because it
was partially worthless.3 More broadly speaking, we are asked to
3
Petitioner has the burden of proof because the examination
commenced before July 22, 1998, the effective date of sec. 7491.
See Internal Revenue Service Restructuring and Reform Act of
1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727.
- 14 -
decide whether a creditor may deduct a bad debt where the
creditor’s actions contributed to the debtor’s default.
We proceed by explaining the general legal principles
surrounding partial bad debt deductions under section 166(a)(2).
We then analyze and distinguish a Court of Federal Claims case
concerning a similar issue.
General Rules Under Section 166
Whether a debt has become partially worthless is a facts and
circumstances determination. Sec. 166(a)(2); sec. 1.166-2(a),
Income Tax Regs. A taxpayer can establish worthlessness by
showing that a debt has neither current nor potential value.
Dustin v. Commissioner, 53 T.C. 491, 501 (1969), affd. 467 F.2d
47 (9th Cir. 1972).
Though the Commissioner’s determination is generally
presumed correct, the Commissioner must reasonably exercise his
discretion. Brimberry v. Commissioner, 588 F.2d 975, 977 (5th
Cir. 1979), affg. T.C. Memo. 1976-209; Portland Mfg. Co. v.
Commissioner, 56 T.C. 58, 72 (1971), affd. on other grounds 35
AFTR 2d 75-1439, 75-1 USTC par. 9449 (9th Cir. 1975). The
Commissioner’s exercise of discretion regarding a bad debt should
not be reversed unless it is plainly arbitrary and unreasonable.
Ark. Best Corp. & Subs. v. Commissioner, 800 F.2d 215, 221 (8th
Cir. 1986), affg. in part and revg. in part 83 T.C. 640 (1984),
affd. on other grounds 485 U.S. 212 (1988); Brimberry v.
- 15 -
Commissioner, supra; Findley v. Commissioner, 25 T.C. 311, 318
(1955), affd. 236 F.2d 959 (3rd Cir. 1956).
Whether a bad debt deduction is proper must be analyzed
according to "reasonableness, commonsense and economic reality."
Scovill Mfg. Co. v. Fitzpatrick, 215 F.2d 567, 570 (2d Cir. 1954)
(quoting Belser v. Commissioner, 174 F.2d 386, 390 (4th Cir.
1949), affg. 10 T.C. 1031 (1948)). In addition, the
Commissioner’s discretion is not absolute, and the Commissioner
cannot ignore the sound business judgment of a corporation’s
officers. Portland Mfg. v. Commissioner, supra at 73 (upholding
a partially worthless debt deduction where corporate officers
concluded that the debtor had no value as a going concern, and
corporation could recover only the value of the debtor’s assets).
All pertinent evidence is considered in determining
worthlessness. See sec. 1.166-2, Income Tax Regs. The evidence
to be considered includes the value of the collateral securing
the debt and the financial condition of the debtor. Sec. 1.166-
2(a), Income Tax Regs. Legal action to enforce payment is not
required where the surrounding circumstances indicate that a debt
is worthless and legal action would likely not result in
satisfactory relief. Sec. 1.166-2(b), Income Tax Regs. A debt
has been found not to be worthless where the debtor is a going
concern with the potential to earn a future profit. Liggett’s
- 16 -
Estate v. Commissioner, 216 F.2d 548, 549-50 (10th Cir. 1954),
affg. a Memorandum Opinion of this Court.
A taxpayer must generally show that identifiable events
occurred to render the debt worthless during the year in which
the taxpayer claimed the deduction. Am. Offshore, Inc. v.
Commissioner, 97 T.C. 579, 593 (1991). Some objective factors
include declines in the value of property securing the debt, the
debtor’s earning capacity, events of default, the obligor’s
refusal to pay, actions the obligee took to pursue collection,
subsequent dealings between the obligee and obligor, and the
debtor’s lack of assets. Id. at 594. No single factor is
conclusive. Id.
Petitioner has shown that a series of specific, identifiable
events occurred during 1995 that, when taken together, rendered
the Properties loan worthless. See id. at 593. The most
important of these events was the failure of the expected source
for repayment of the Properties loan, the G&K purchase. Bottlers
anticipated that Properties would own the bottling facilities for
only a short time while G&K prepared to buy them. When G&K could
no longer buy the facilities, the structure became untenable.
Another event that contributed to the worthlessness of the
Properties loan was that Bottlers opted not to pay Properties a
portion of the rent for valid business reasons, rendering it
impossible for Properties to pay Bottlers the principal on the
- 17 -
loan because it did not have the cashflow.4 Third, soon after
Bottlers learned that G&K would not be able to purchase the
facilities, Bottlers combined with Brooks Beverage to become
BevAm, and the Properties structure no longer was necessary.
Finally, an appraisal revealed the bottling facilities were worth
just under $8 million. These specific, identifiable events
combined to result in the worthlessness of the Properties loan in
1995.
Respondent argues that Properties was a going concern with
potential value in 1995 and that therefore, the Properties loan
was not partially worthless during that year. See Crown v.
Commissioner, 77 T.C. 582 (1981); Findley v. Commissioner, 25
T.C. 318. Respondent argues that Properties had sufficient
income and/or sufficient assets to satisfy its loan obligations.
Respondent sets forth several ways in which Properties could have
met its obligations. For example, respondent argues that
4
Respondent argues that there is no evidence that Bottlers
failed to pay Properties the full amount of rent due on the
lease. We disagree. We found the testimony of Mr. Trebilcock,
the chairman and president of Bottlers, to be credible on this
point. Petitioner also introduced Properties’ accounting records
as evidence that Bottlers did not pay the full amount of rent for
1994 and 1995. Moreover, had Bottlers paid Properties the full
amount of rent, Properties eventually might have not had the cash
to pay Bottlers the principal on the Properties loan anyway
because Properties might be required to pay taxes on the rental
income it received from Bottlers, depleting its cash. This cash
depletion was precisely what the management group was attempting
to avoid by having Bottlers pay Properties only a portion of the
rent due.
- 18 -
Properties could have exercised its rights under the lease to
cause Bottlers to buy the facilities when Bottlers failed to pay
the full amount of rent. Respondent further argues that
Properties could have found another third party to buy the
facilities.
Respondent’s focus on the theoretical possibilities of what
might occur does not give sufficient credence to the realities of
the business environment. See Portland Mfg. Co. v. Commissioner,
56 T.C. 72. One of respondent’s theoretical suggestions, for
example, is that Properties should have caused Bottlers to buy
the facilities once Bottlers failed to pay the full amount of
rent. This decision would not have been in the best interests of
Bottlers, and the management group, owing fiduciary duties to
Bottlers, would not have made it. There were also no other
third-party buyers for the bottling facilities, although
respondent suggests other actions Bottlers should have taken to
seek them. The management group searched fruitlessly for other
third parties when the G&K deal collapsed.
While the management group may have made other choices if
they had the benefit of hindsight, they did what they thought was
best for Bottlers based on the circumstances at the time. See
id. Properties was unable to repay the loan once G&K’s financing
fell through and G&K became unable to purchase the facilities.
Cf. Crown v. Commissioner, supra; Findley v. Commissioner, supra.
- 19 -
The structure of the transactions ensured that there was no
source of funds for Properties. Respondent’s hypothesizing over
what could or should have been done ignores the realities of the
business and is unreasonable. Respondent’s determination that
the Properties loan was not worthless in 1995 therefore was
arbitrary, unreasonable, and an abuse of discretion.
We find that the Properties loan was partially worthless in
1995.
Bad Debt Deduction Where Creditor’s Actions Contribute to
Worthlessness
We next consider whether petitioner may deduct the
Properties loan as partially worthless although the legitimate
business decisions of petitioner’s predecessor, Bottlers,
contributed to the worthlessness of the Properties loan.
Respondent argues that Bottlers failed to pay the full amount of
rent, which, in turn, caused Properties to be unable to repay the
loan. Respondent argues that petitioner is therefore not
entitled to the deduction. We disagree. Petitioner’s legitimate
business decisions contributing to the worthlessness of the
Properties loan do not preclude the bad debt deduction.
It is well settled that certain actions of a creditor do
preclude bad debt deductions. For example, a taxpayer may not
voluntarily release a solvent debtor and then claim a deduction
for a worthless debt. Roth Steel Tube Co. v. Commissioner, 620
F.2d 1176 (6th Cir. 1980), affg. 68 T.C. 213 (1977); Am. Felt Co.
- 20 -
v. Burnet, 58 F.2d 530, 532 (D.C. Cir. 1932), affg. 18 B.T.A. 504
(1929). A creditor who voluntarily relinquishes valuable
collateral provided by a solvent debtor also may not deduct the
debt as worthless. O’Bryan Bros. v. Commissioner, 127 F.2d 645,
646 (6th Cir. 1942), affg. 42 B.T.A. 18 (1940).
Neither party was able to point us to a case directly on
point. Respondent relies on a recent Court of Federal Claims
decision indicating that a taxpayer may not deduct a worthless
debt where the taxpayer’s actions, standing alone, have made the
debt uncollectible. PepsiAmericas, Inc. v. United States, 52
Fed. Cl. 41 (2002). Respondent argues that we should extend the
reasoning of PepsiAmericas to this case to hold that petitioner
may not deduct a portion of the Properties loan as a worthless
debt because Bottlers contributed to its worthlessness by failing
to pay Properties the full amount of rent.
In PepsiAmericas, the taxpayer made a loan to its ESOP,
terminated the ESOP, and tried to deduct the amount the ESOP owed
as a worthless debt. Id. The court held the taxpayer could not
deduct the amount lent to the ESOP as a worthless debt because
the taxpayer’s own conduct caused the worthlessness. Id. at 48
(citing Roth Steel Tube Co. v. Commissioner, supra at 1181,
- 21 -
O’Bryan Bros., Inc. v. Commissioner, supra at 646, and Am. Felt
Co. v. Burnet, supra at 532).5
PepsiAmericas is not controlling. There are significant
differences between the facts of PepsiAmericas and the facts
here. Control is the first major difference. PepsiAmericas
controlled the entity whose debt it caused to become worthless.
PepsiAmericas, Inc. v. United States, supra. In contrast,
Bottlers did not control Properties. While the management group
had some ownership of both entities, the parties stipulated that
the entities themselves were not related. Bottlers itself could
not control the decisions of Properties, alter the ownership of
Properties, or cause Properties to take any actions whatsoever
other than under the lease and the loan.
The cause of the worthlessness is the second major
difference. While PepsiAmericas terminated its ESOP and thus
unilaterally caused the ESOP to be unable to pay its debts,
several factors contributed to the worthlessness of the
5
The PepsiAmericas and O’Bryan cases broadly interpret other
cases involving this issue. See PepsiAmericas, Inc. v. United
States, 52 Fed. Cl. 41, 48 (2002) (citing Roth Steel Tube Co. v.
Commissioner, 620 F.2d 1176, 1181 (6th Cir. 1980), affg. 68 T.C.
213 (1977); O’Bryan Bros. v. Commissioner, 127 F.2d 645, 646 (6th
Cir. 1942), affg. 42 B.T.A. 18 (1940); and Am. Felt Co. v.
Burnet, 58 F.2d 530, 532 (D.C. Cir. 1932), affg. 18 B.T.A. 504
(1929)). A narrower interpretation is that a creditor cannot
release a solvent debtor and then claim a deduction for a
worthless debt. Roth Steel Tube Co. v. Commissioner, supra;
O’Bryan Bros. v. Commissioner, supra; Am. Felt Co. v. Burnet,
supra.
- 22 -
Properties loan. See id. at 45. The key contributing factor to
Properties’ inability to repay the loan was G&K’s failure to
obtain financing, wholly out of the control of Bottlers.
Properties anticipated that G&K would purchase the bottling
facilities, but ultimately G&K could not. While Bottlers’
failure to pay the full amount of rent due contributed to the
worthlessness of the loan,6 other factors contributed as well.
These two significant differences convince us that it would be
inappropriate to follow PepsiAmericas here.
We also decline respondent’s invitation to articulate an
absolute rule that a taxpayer may never deduct a debt as
worthless if the taxpayer contributed to the worthlessness. We
find that legitimate business decisions contributing to the
worthlessness of a debt do not preclude a bad debt deduction in
these circumstances. Cf. PepsiAmericas, Inc. v. United States,
supra at 48. Accordingly, we find that petitioner may deduct the
worthless portion of the Properties loan notwithstanding that
Bottlers’ actions contributed to its worthlessness.
6
Even if Bottlers had paid the full amount of the rent due
under the lease, Properties still might have been unable to
satisfy its obligations under the loan without a third party
purchasing the bottling facilities. Properties would not be able
to deduct principal payments it paid Bottlers on the loan and
would thus have more income than deductions, giving rise to
income tax liability. This liability would ruin the net zero
cashflow effect of the deal and would cause Properties to be
unable to repay the loan.
- 23 -
Conclusion
Petitioner may deduct $10 million as a worthless debt in
1995. The Properties loan was partially worthless in 1995
because identifiable events occurred during that year that made
it certain that Properties would be unable to repay it.
Respondent’s determination to the contrary was unreasonable and
an abuse of discretion. Although petitioner’s predecessor,
Bottlers, may have contributed to the worthlessness of the
Properties loan, this action does not preclude petitioner from a
bad debt deduction where other major business factors contributed
to the worthlessness.
In reaching our holding, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
moot, irrelevant, or without merit.
To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.