Laidlaw Transportation, Inc. V. Commissioner
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LaidLaw Transportation, Inc. v. CommissionerFACTS: Laidlaw, Inc. (LTL) is a public-traded Canadian corporation that has international subsidiaries that involved in trucking, solid waste services, and passenger and school bus services. During the years in issue (1985-1988), DeGroote and his management team controlled all of the Laidlaw companies. Laidlaw Transportation, Inc. (LTI) and Laidlaw Industries, Inc. (LII) are LTL’s U.S. subsidiaries. LTI owned 100% of Laidlaw Transit, Inc. (Transit) and Tree Services, Inc. (Tree), and their several subsidiaries. Meanwhile, LII wholly owned Laidlaw Waste Systems, Inc. (LWSl).In 1980, to gain advantage over its competitors in buying solid waste services businesses, DeGrotte and other directors were advised by their accountants to form Laidlaw Investment, Inc. (LIL) as a wholly-owned Canadian subsidiary, and then form Laidlaw International Investments B.V. (LIIBV), a Netherlands subsidiary. The accountants claimed under this plan the Laidlaw group would have “double deduction” treatment of interest expense (interest deduction in both Canada and the U.S.), with minimum income tax liabilities in The Netherlands, Canada, or the U.S.During the years in issue, LIIBV’s primary activity was to receive funds from LIL and generally on the same or next day, LIIBV transferred the funds to the U.S. subsidiaries including Transit, LWSI, and Tree. In addition, LIIBV advanced funds only to Laidlaw’s U.S. subsidiaries and the funds came almost exclusively from LIL and from the payments of interest from the subsidiaries.Throughout the years in issue, LIIVB totally advanced $975 million in total to Transit, LWSI, and Tree (The U.S. subsidiaries). The borrowers used the funds advanced mostly as capital expenses, for example, acquiring stock, expanding operations, and repaying loans. Meanwhile, the U.S. subsidiaries transferred $133 million claimed as interest payments to LLBV during those years. However, on the same day that LIIBV received the “interest payments” from the borrowers, LIIBV transferred an amount equal or close to the payments back to its borrowers in what the borrowers called interest reinvestment loans. The borrowers record such transactions as interest payments on their books.Initially, the agreement between LIIBV and the U.S. subsidiaries receiving the advances included fixed payment repayment date and rate of, the obligation to repay principal and interest, and a requirement that Transit must maintain a certain long-term debt to equity Unlike bank loans, LIIBV advances were generally not limited. The initial loan agreement did not require borrowers to make quarterly or semiannual payments of principal and permitted the borrowers to convert the loans to 5-year loan before or on the maturity date.
In fact, none of the subsidiaries repaid any principal to LLIBV from the date of the initial advance in December 1985 to October 1989. The borrowers repeatedly extended the due date fro most of the principal amounts owned. Furthermore, the borrowers did not have enough cash-flow during the years in issue to repay the advances. LIIBV’s management did not intend to expect or request any repayment.On audit, the IRS asserted the loans were equity in substance and disallowed the $133.5 million interest deductions claimed by the U.S. subsidiaries. The Tax Court agreed with the IRS and determined deficiencies in petitioners’ Federal Income tax.ISSUE: Whether the $975 million intercompany loans from LTL’s wholly owned Dutch subsidiary to the U.S. subsidiaries characterized as debt or as equity?HOLDING: The intercompany loans made by LTL’s Dutch subsidiary to its U.S. subsidiaries should be treated as equity and the company cannot deduct the over $133 million as interest.ANAYLYSIS: The U.S. Court of Appeals for the Fifth Circuit has identified 13 nonexclusive factors (the Mixon factors) to determine whether advances are debt or equity. However, the U.S. tax court concluded that the transactions between the Dutch subsidiary and the U.S. subsidiaries are not at arm’s length because DeGroote and his management team controlled all the Laidlaw entities during the years in issue. Considering the entities did not deal at arm’s length, the tax court gave more weight to the Mixon factors to substance than to the form of the transaction.One of the Mixon factors provides that the name given to the advances documents suggests whether advances are debt or equity. Although the advances agreement between the entities labeled the advances at issue as debt, the tax court considered the labels on the document might not truly reflect the facts and circumstances of the case. Therefore less weight was given here to the form than to the substance of the transaction.The tax court concluded that the following factors favors treating the advances to the U.S. subsidiaries as equity rather than debt: