Laidlaw Transportation, Inc. V. Commissioner

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- The repeated postponement of maturity date

The Mixon factor provides the presence of a fixed maturity date can indicate an advance was debt. Although there was a fixed maturity date stated in the initial advanced agreement, the tax court gave more weight to the substance of the transactions, considering the fact that LIIBV did not expect the recipient to repay and the agreements further changed the fixed maturity to payment on demand. Without a fixed due date, it may indicate that the advances is equity.

(2) The borrowers’ insufficient liquid assets or reasonably anticipated cash-flow to repay the principal or the interest balance

This factor is somewhat subjective because there are several approaches to measure liquid assets and available cash flow. The tax court used the EBITDA minus CAPEX method to analysis the U.S. subsidiaries’ cash-flow and found that LII’s and LIT’s cash-flow for the each of the 3 years in issue were negative indicating that the borrowers could not repay the advances with their liquid assets. The borrowers argued that the method tax court used was incorrect and they had many sources from which to repay the advances. However, borrowers’ argument did not convince the court. The factor favors treating the advances as equity.

(3) Failure to demand timely repayment resulting in the subordination of intercompany debt to outside creditors

Although the intent of the parties entering into the postponement agreements was not to subordinate the debt to the rights of the commercial banks, because the commercial banks relied on the agreements, which were enforceable under Canadian law, tax concluded that failure of requesting timely repayment could consider as subordinates intercompany debt to the rights of other creditors who receive payment in the interim.

(4) The objective facts in the intent of the transaction

Although the borrowers stated the advances as loans interest, the tax court considered that is not the same as intending the advances as debt.

(5) The inadequate capitalization of the borrowers

This is a subjective factor because there can be different ways to testify the value of U.S. subsidiaries during the years in issue. The tax court concluded the U.S. subsidiaries were thinly capitalized because the debt-equity ratio was too high especially after acquiring GSX and the borrowers realized that it would worsen. The advances were mainly used on purchasing capital assets. The borrowers argued the debt-equity ratio should be computed using fair market values rather than book values. However, considering the fact that none of the loan documents stated the ratio were base on fair market value and borrowers’ ratio was not still worsen than their competitors using either fair market values or book values, the tax court concluded the borrowers has inadequate capitalization. The factor supports treating the advances as equity.

(6) The circular flow of funds

Although the borrowers paid what they claimed as interest payment to LIIBV, the transactions did not change the borrowers’ economic status because LIIBV immediately return the same or close amount of money to the borrowers as interest reinvestment loans. The tax court concluded there is a circular flow of funds among entities and borrowers, in substance, paid no interest to LIIBV.

(7) The inability to obtain the same amount of loan from outside sources with the same terms of agreement with LIIBV

(8) The fact that no principal was repay on the due date, a solid objective factor that based on fact and circumstance.

The factors related to the form of transaction favors treating the advances to the U.S. subsidiaries as debt while the factors related to the substance of the transaction support treating the advances as equity. Base on the facts and circumstance in each case, the tax court gave less weight to the form than to the substance of the transaction. Therefore, the tax court concluded that the advances from LIIBV to the petitioners, the U.S. subsidiaries, are equity. The U.S. subsidiaries may not deduct the interests they claimed in the year of 1986, 1987, and 1988.