UNITED STATES TAX COURT



CHARLES H. DAVISON AND LESSIE B. DAVISON, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 15887-94.                    Filed August 26, 1996.


     W, a cash basis partnership, entered into an
agreement in 1980 to borrow up to $29 million from J.
J made an initial disbursement of $19,645,000.
Pursuant to the loan agreement, J applied $227,647.22
of the initial disbursement as a credit for interest W
owed to J on a previous loan. Pursuant to a subsequent
modification of the 1980 loan agreement, J agreed to
advance $1,587,310.46 to W to enable W to satisfy its
current interest obligation to J. J made a wire
transfer of $1,587,310.46 to W's bank account on Dec.
30, 1980. On Dec. 31, 1980, W made a wire transfer to
J to satisfy W's current interest obligation. The net
effect of the Dec. 30-31 transaction was to increase
the principal amount of W's loan from J by
$1,587,310.46. W claimed interest deductions of
$227,647.22 and $1,587,310.46 and reported an ordinary
loss on its partnership return for 1980.
                               - 2 -


          R disallowed W's interest deductions, determining
     that the interest had not been "paid" but merely
     postponed. R adjusted Ps' distributive share of W's
     ordinary loss accordingly.

          Held: W is not entitled to interest deductions
     under sec. 163(a), I.R.C. A cash basis borrower is not
     entitled to an interest deduction where the funds used
     to satisfy the interest obligation were borrowed for
     that purpose from the same lender to whom the interest
     obligation was owed. In those circumstances, there has
     been no "payment" of interest; rather, "payment" has
     merely been postponed.


     John S. Brown, George P. Mair, William A. Hazel, Matthew D.

Schnall, Donald-Bruce Abrams, and Joseph L. Kociubes, for

petitioners.

     Charles W. Maurer, Jr., for respondent.


                              OPINION


     RUWE, Judge:    Respondent determined deficiencies of $753

and $402,169 in petitioners' 1977 and 1980 Federal income taxes,

respectively.   After a concession by respondent, the issue for

decision is whether White Tail, a general partnership, "paid"

interest when it borrowed the funds used to satisfy its interest

obligations from the same lender to whom the interest was owed.

Petitioner Charles H. Davison was a partner in White Tail, and

petitioners claimed their distributive share of the ordinary loss

reported by White Tail on their 1980 Federal income tax return.
                               - 3 -

                            Background


     This case was submitted fully stipulated.   The stipulation

of facts and the first supplemental stipulation of facts are

incorporated herein by this reference.   Petitioners resided in

Greenwich, Connecticut, at the time they filed their petition.

Petitioners were calendar year, cash basis taxpayers.

     Petitioner Charles H. Davison is a certified public

accountant.   During 1979, he was head partner of the accounting

firm Peat, Marwick & Mitchell, where he was associated with

Samuel J. Esposito and John L. Vitale, who were also partners.

     On February 1, 1979, Messrs. Davison, Esposito, and Vitale

formed White Tail, a general partnership organized under Illinois

law, for the purpose of entering into the agricultural business

of acquiring, cultivating, and selling farm properties.    Each of

the partners had a one-third interest in the profits, losses, and

distributions of White Tail.   White Tail reported its income on a

calendar year basis using the cash method of accounting.

     On or about March 16, 1979, White Tail acquired

approximately 11,000 acres of real property located in Hyde

County, North Carolina, and certain related personal property.

On or about May 2, 1980, White Tail acquired approximately 7,747

acres of real property located in Hyde and Tyrrell Counties in

North Carolina.
                                 - 4 -

     In 1979, White Tail realized $248,198 in gross revenues from

farming operations and incurred $868,684 in operating expenses,

exclusive of interest expense.    In 1980, White Tail realized

$2,098,717 in gross revenues from farming operations and incurred

$2,784,169 in operating expenses, exclusive of interest expense.


White Tail's Credit Arrangements With John Hancock


     On December 21, 1978, the John Hancock Mutual Life Insurance

Co. (John Hancock) issued to Messrs. Davison, Esposito, and

Vitale a commitment to make a first mortgage loan on the White

Tail property in an amount up to $9 million.1       By a promissory

note dated March 16, 1979, White Tail and John Hancock

established the credit arrangement contemplated by this $9

million mortgage loan commitment.2       Subsequently, on January 28,

1980, John Hancock issued to White Tail a First Mortgage Loan

Commitment pursuant to which John Hancock agreed to advance White

Tail a maximum amount of $29 million.       The First Mortgage Loan

     1
      This commitment preceded the actual formation of White Tail
and its acquisition of property.
     2
      In connection therewith, White Tail executed a Deed of
Trust and Security Agreement. Messrs. Davison, Esposito, and
Vitale also executed a Guaranty of Note, Deed of Trust and
Mortgage in the amount of $1 million, with the maximum individual
liability of each guarantor limited to one-third of this amount.
In addition, Brad Hill Farms (Brad Hill), another partnership of
Messrs. Davison, Esposito, and Vitale, executed a mortgage of
certain Illinois real property as further security for the $9
million promissory note. White Tail and John Hancock modified
their agreement with a Modification of Promissory Note and Deed
of Trust and Security Agreement, dated Dec. 4, 1979.
                               - 5 -

Commitment required that White Tail use a portion of the funds

borrowed to retire existing indebtedness to John Hancock,3 and

envisioned that additional amounts would be advanced to White

Tail up to the aggregate principal amount of $29 million.

     By a promissory note dated May 2, 1980, White Tail and John

Hancock established the 1980 John Hancock credit arrangement (the

1980 credit arrangement), as contemplated by the First Mortgage

Loan Commitment.4   This promissory note required White Tail to

pay interest on its borrowings at an annual rate of 12.25

percent, payable every January 1 commencing January 1, 1981.      The

promissory note also entitled John Hancock to 20 percent of White

Tail's net farm income, as well as 20 percent of White Tail's net

profits from land sales.

     Pursuant to the establishment of the 1980 credit

arrangement, John Hancock made initial disbursements on May 7,

1980, totaling $19,645,000.   A portion of the $19,645,000


     3
      The First Mortgage Loan Commitment stated that White Tail's
existing indebtedness to John Hancock was $6 million.
     4
      In connection with the execution of the May 2, 1980,
promissory note and the establishment of the 1980 credit
arrangement, White Tail executed a Deed of Trust and Security
Agreement and an Option Agreement. Moreover, each of White
Tail's partners executed a Guaranty of Note, Deed of Trust and
Mortgage. The Guaranty of Note provided that each partner
guaranteed the payment of one-third of the amount owed under the
1980 credit arrangement, up to a maximum amount of $1 million.
Brad Hill also executed a Guaranty of Note, Deed of Trust and
Mortgage. The Deed of Trust and Security Agreement was amended
by an Amendment to Deed of Trust and Security Agreement, dated
Aug. 26, 1980.
                               - 6 -

consisted of a credit to White Tail's prior loan account with

John Hancock for $6,480,000 to pay off the principal that White

Tail owed pursuant to the prior credit arrangement, and a credit

to White Tail's prior loan account for $227,647.22 to satisfy the

interest obligation that had accrued on the prior loan.

     The 1980 credit arrangement required White Tail to make an

interest payment on January 1, 1981.   The amount of interest due

was $1,587,310.46.   Pursuant to the terms of the 1980 credit

arrangement, one-half of the interest could be borrowed from John

Hancock.   The 1980 credit arrangement also called for a principal

payment of $7,707.50 on the same date.

     White Tail needed to satisfy the requirements set forth in

the First Mortgage Loan Commitment in order to become eligible to

make additional borrowings under the 1980 credit arrangement.

These additional borrowings were characterized as "Land

Development" and "Operating Funds" borrowings.   Under the terms

of the First Mortgage Loan Commitment, the 1980 disbursement for

"Operating Funds" was subject to the following provision:


     If the Borrower's Net Farm Income is insufficient to
     fund the interest accrued on the loan contemplated
     herein from date of closing to December 31, 1980, John
     Hancock shall disburse sufficient proceeds of this loan
     to fund said interest shortage; provided, however, that
     the amount of said Disbursement for Operating Funds
     shall not exceed 50% of the actual accrued interest
     during said period, and provided further that John
     Hancock's said Disbursement for such interest shortage
     shall not be disbursed until Borrower has advanced its
     portion of the actual accrued interest.
                               - 7 -

Similar provisions covered the disbursement of operating funds

for 1981-83.   The 1980 credit arrangement remained in effect from

May 2, 1980, through June 1983.

     White Tail's business was unprofitable,5 and, in December

1980, Mr. Esposito requested that John Hancock modify the terms

of the 1980 credit arrangement in order to prevent a default.      On

December 24, 1980, John Hancock mailed a Letter of Agreement

(Letter Agreement) to White Tail c/o Mr. Esposito.    The Letter

Agreement states:


     Gentlemen:

     Reference is made to the enclosed Vote #3, Page Three
     approved December 23, 1980 by our Agricultural
     Investment Committee, and approved today by our
     Committee of Finance, in which vote we have authorized
     the Modification of the legal papers evidencing and
     securing the above referenced loan.

     Said Modification will capitalize certain interest due
     from you on January 1, 1981 and will defer certain
     principal due from you on the same date, all as set
     forth in said vote. Said Modification will further
     increase John Hancock's participation in the property's
     defined Operating Income and in the Security's
     Appreciation, also all as set forth in said enclosed
     Vote.

               *    *     *       *    *    *     *

     You have asked us to enter into this Letter of
     Agreement with you this week, in advance of our
     referrel [sic] to counsel and his preparation of the
     definitive documentation, in order to prevent a default
     in your payment due January 1, 1981.



     5
      See supra p. 4.
                               - 8 -

     If this Letter of Agreement is to become effective, you
     must sign the enclosed copy hereof and return the same
     to me at the Home Office, so that the same is received
     by me prior to December 31, 1980.

Attached to the Letter Agreement were the minutes from a December

23, 1980, meeting of John Hancock's Agricultural Investment

Committee stating that the committee voted to accept the

following modification of the 1980 credit arrangement:


     To capitalize $793,655.23 of the $1,587,310.46 interest
     due January 1, 1981 and to defer the $7,707.50
     principal installment due January 1, 1981 until January
     1, 2001, the final maturity under FML [Farm Mortgage
     Loan] #161177, White Tail Farm, 19,344 acres secured by
     a First Mortgage loan in North Carolina and Illinois in
     consideration of White Tail Farm providing John Hancock
     Participation as follows:

          Between July 1, 1981 and January 1, 1991[,] 22% of
     Net Farm Income and 22% of the Net Profit From Land
     Sales[;]

                                and

          Between January 2, 1991 and January 1, 2001[,] 25%
     of Net Farm Income and 25% of the Net Profit From Land
     Sales over Value Assigned To Land;

     rather than 20% of Net Farm Income and 20% of the Net
     Profit From Land [Sales] as originally provided.


Mr. Esposito signed the Letter Agreement on behalf of White Tail.

     On December 30, 1980, John Hancock made a wire transfer of

$1,587,310.46 to White Tail's account at the American National

Bank and Trust Co. of Chicago (American National).   This transfer

increased the amount White Tail owed to John Hancock by

$1,587,310.46.   This amount is reflected as a deposit into the
                                - 9 -

American National account on December 30, 1980.    On December 31,

1980, White Tail made a wire transfer of $1,595,017.96 to John

Hancock, representing $7,707.50 of principal and $1,587,310.46 in

interest due under the 1980 credit arrangement.6

     The purpose of the $1,587,310.46 advance from John Hancock

was to provide White Tail with sufficient funds to satisfy the

interest due John Hancock on January 1, 1981, under the terms of

the 1980 credit arrangement, as modified.    White Tail's general

ledger showed that its bank account at American National, as of

December 31, 1980, was overdrawn with a negative balance of

$138,931.80.7

     On their 1980 Federal income tax return, petitioners

reported an ordinary loss of $946,613 as their distributive share

of the $2,839,839.09 ordinary loss reported by White Tail on its

U.S. Partnership Return of Income (Form 1065) for 1980.    On June

6, 1994, respondent issued a notice of deficiency adjusting

petitioners' distributive share of the ordinary loss reported by

White Tail.8    In particular, respondent disallowed the interest

     6
      There is no explanation of why the $7,707.50 principal
payment was not deferred in accordance with the modification of
the 1980 credit arrangement.
     7
      This amount includes outstanding checks that had been
written on, but had not yet cleared, White Tail's American
National account. This amount is also shown as a liability on
White Tail's 1980 U.S. Partnership Return of Income (Form 1065).
     8
      Respondent also adjusted petitioners' medical expense
deduction for 1980 in the amount of $10,029 and their investment
                                                   (continued...)
                                - 10 -

deductions for amounts that White Tail claimed to have "paid" to

John Hancock on May 7 and December 31, 1980, in the respective

amounts of $227,647.22 and $1,587,310.46.9     Respondent adjusted

petitioners' distributive share of White Tail's ordinary loss

accordingly.


                              Discussion


     Before we analyze the transactions in issue, it is

appropriate to state some general principles with respect to

interest deductions.     Section 163(a)10 generally permits a

deduction for "all interest paid or accrued within the taxable

year on indebtedness."     For cash basis taxpayers, payment must be

made in cash or its equivalent.     Don E. Williams Co. v.

Commissioner, 

, 577-578 (1977); Eckert v. Burnet, 

, 141 (1931); Menz v. Commissioner, 

, 1185

(1983).   The delivery of a promissory note is not a cash

equivalent but merely a promise to pay.     Helvering v. Price, 309

     8
      (...continued)
tax carryback to 1977 in the amount of $753.     Both of these items
are computational adjustments.
     9
      Respondent also disallowed an interest deduction for
$17,897.04 that was borrowed from John Hancock and paid to J.H.
Cochrane. Respondent now concedes that White Tail is entitled to
a deduction for its interest payment of $17,897.04 to J.H.
Cochrane.
     10
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                                - 11 -

U.S. 409, 413 (1940); Nat Harrison Associates, Inc. v.

Commissioner, 

, 624 (1964).     Where a lender withholds

a borrower's interest payment from the loan proceeds, the

borrower is considered to have paid interest with a note rather

than with cash or its equivalent and, therefore, is not entitled

to a deduction until the loan is repaid.     Menz v. 

at 1186; Cleaver v. Commissioner, 

, 454, affd.

(7th Cir. 1946).    On the other hand, where a

taxpayer discharges interest payable to one lender with funds

obtained from a different lender, the interest on the first loan

is considered paid when the funds are transferred to the first

lender.   Menz v. 

; Crown v. Commissioner, 

, 593-595 (1981).   With these general principles in mind,

we proceed to look at the specific transactions in issue.

Because the December 30-31, 1980, transaction presents the more

difficult issue, we address it first.

     Under the terms of the 1980 credit arrangement, an interest

payment and a principal installment were due from White Tail on

January 1, 1981.   In the 1980 credit arrangement, John Hancock

had agreed to lend White Tail up to 50 percent of the interest

that was due, so long as White Tail was able to provide the

remaining 50 percent.   In December 1980, Mr. Esposito, one of

White Tail's general partners, approached John Hancock and

requested that it agree to modify the 1980 credit arrangement

with respect to the required interest payment, in order to
                              - 12 -

prevent a default by White Tail.    In the Letter Agreement dated

December 24, 1980, it was agreed that John Hancock would modify

the 1980 credit arrangement so as to "capitalize" $793,655.23 of

the $1,587,310.46 interest due from White Tail and defer the due

date for the principal installment until January 1, 2001.11    In

the original 1980 credit arrangement, John Hancock had already

agreed to lend one-half of the interest due on January 1, 1981.

The effect of the modification was that all the interest due to

John Hancock on January 1, 1981, would be borrowed from John

Hancock.

     On December 30, 1980, John Hancock wired $1,587,310.46 to

White Tail's account at American National.   This increased the

amount White Tail owed John Hancock by $1,587,310.46.   On

December 31, 1980, White Tail wired John Hancock $1,595,017.96,

which John Hancock reflected as a satisfaction of White Tail's

January 1, 1981, interest obligation of $1,587,310.46 plus a

principal payment of $7,707.50.12




     11
      We construe the term "capitalize", as used in the Letter
Agreement and the minutes, to mean that the principal of the loan
would be increased by the amount of interest due on Jan. 1, 1981.
     12
      The Letter Agreement dated Dec. 24, 1980, and the attached
minutes indicate that John Hancock was going to allow White Tail
to defer the principal payment of $7,707.50. Nevertheless, on
Dec. 29, 1980, John Hancock billed White Tail for both principal
and interest, and the wire transfer of $1,595,017.96 includes a
principal payment of $7,707.50. The record contains no
explanation for this.
                               - 13 -

     The purpose of John Hancock's $1,587,310.46 advance to White

Tail on December 30, 1980, was to provide White Tail with

sufficient funds to satisfy the interest due John Hancock on

January 1, 1981.   Petitioners argue that White Tail paid this

interest when it made the wire transfer to John Hancock on

December 31, 1980.   Respondent contends that interest has not

been paid but merely postponed, and, consequently, White Tail is

not entitled to a deduction under section 163(a).

     On brief, petitioners place particular reliance on prior

decisions of this Court in which the deductibility of interest

paid to a lender, with funds borrowed from the same lender, turns

on whether the borrower exercised "unrestricted control" over the

funds borrowed.    Petitioners argue that they are entitled to a

deduction pursuant to section 163(a), because White Tail

possessed unrestricted control of the $1,587,310.46 wired from

John Hancock to White Tail's account at American National on

December 30, 1980.

     The concept of "unrestricted control" in cases of this

nature had its origin in Burgess v. Commissioner, 

(1947).   In Burgess, a cash basis taxpayer originally borrowed

$203,988.90.   On December 20, 1941, just prior to the due date of

his interest payment, the taxpayer borrowed an additional $4,000

from the same lender, deposited the lender's check in the

taxpayer's checking account, and commingled the $4,000 with other

funds in the account.    On December 26, 1941, the taxpayer drew a
                              - 14 -

check on this account in the amount of $4,219.33 to cover

$4,136.44 of interest due on the original loan plus $82.89 of

prepaid interest on the $4,000 loan.   At the time the taxpayer's

check was drawn, the taxpayer had $3,180.79 in his account in

addition to the $4,000 borrowed on December 20, 1941.

     In a Court-reviewed opinion, we allowed the deduction.      We

rejected the Commissioner's argument that the taxpayer had simply

substituted a note in place of the interest payable.    We found

that the taxpayer did not apply for the loan for the sole purpose

of obtaining funds to pay interest, and the lender did not grant

the loan for that exclusive purpose.   We also found that the

taxpayer had several bills that were due, needed sufficient funds

to pay them as well as the interest, and commingled the loan

proceeds with other funds in his account, causing them to lose

their identity.   As a result, we found that the loan proceeds

could not be traced to the payment of interest.    

     Six judges dissented from the majority's holding.    They

believed that the facts demonstrated that the taxpayer borrowed

the $4,000 for the purpose of paying interest.    They believed

that the substance of what occurred was no different than where a

taxpayer simply executes a note to the lender in satisfaction of

the current interest obligation.

     In Burgess v. 

, the purpose of the second

loan was obviously an important factor.   However, our subsequent

opinions relying on Burgess began to focus mostly on whether the
                              - 15 -

borrower acquired possession or control over the proceeds of the

second loan.   This was later referred to as unrestricted control.

See Menz v. Commissioner, 

.

     In Burck v. Commissioner, 

(1975), affd. on other

grounds 

(2d Cir. 1976), a cash basis taxpayer

borrowed $5,388,600 from a bank on December 29, 1969.     Pursuant

to negotiations that preceded the loan agreement, $1 million of

these proceeds was deposited into the taxpayer's account at a

second bank.   Prior to this deposit, the taxpayer's other funds

in the account totaled $42,009.02.     On December 30, 1969,

pursuant to the negotiated agreement between the lender and the

taxpayer, $377,202 was transferred from the taxpayer's account

back to the lender for 1 year's prepaid interest on the loan.

     We concluded that the facts in Burck were within the scope

of our decision in Burgess v. 

, and allowed

the interest deduction.   In reaching this decision, we relied

primarily on the fact that the loan proceeds were commingled with

the other funds in the taxpayer's account.     We also pointed out

that the taxpayer owned other assets from which the interest

could have, if need be, been prepaid, even though the taxpayer's

bank account contained insufficient funds to pay the interest.13

     13
      The Court considered the taxpayer's nonliquid assets in
making this determination, even though there was no indication
that these assets could have been liquidated to make the required
interest prepayment in December 1969. See Burck v. Commissioner,

, 557 n.2 (1975), affd. on other grounds 

                                                   (continued...)
                               - 16 -

We also considered the fact that prepayment of the $377,202 in

interest was an "integral part" of the loan agreement because the

bank would not have made the loan without it.   It was clear that

$377,202 of the loan proceeds was advanced for the purpose of

paying interest to the lender.

     Faced with essentially the same fact pattern in Wilkerson v.

Commissioner, 

(1978), revd. and remanded 

(9th Cir. 1981), we followed the reasoning and result of Burck v.

.14   Responding to the Commissioner's argument

that the borrowers never had "unrestricted control" over the loan

proceeds, we stated:


           We have rejected that same argument where the
     lender gave up control of the borrowed funds, the funds
     were commingled with the taxpayer's own funds, and then
     the commingled funds were used to prepay interest.
     Burgess v. Commissioner, 

(1947); Burck v.
     Commissioner, 

(1975), affd. 

     (2d Cir. 1976). [Wilkerson v. 

at
     258].


In Wilkerson, without the loan, the borrowers did not have

sufficient funds with which to satisfy their interest

obligations.   Prior to receipt of the loan proceeds used to

satisfy their interest obligations, the borrowers had checking

     13
      (...continued)
(2d Cir. 1976).
     14
      In Wilkerson v. Commissioner, 

, 259 (1978),
revd. and remanded 

(9th Cir. 1981), we stated that
"The Burgess and Burck cases are not meaningfully distinguishable
from the facts before us."
                               - 17 -

account balances of $2 and $1,873, respectively, while their

respective interest payments were approximately $55,000.   In

response to the Commissioner's argument that there was

insufficient commingling, we stated:


     The partnerships here acquired control of the loan
     proceeds as evidenced by their deposit in the
     partnership checking accounts outside the lender's
     domain. That the partnerships exercised their control
     over the funds for only a brief period of time does not
     convert the transactions into discounted loans. [Id.
     at 260.]


     In Wilkerson, unrestricted control appears to mean

unrestricted physical or mechanical control in the sense that

there were no physical or mechanical restraints on the borrower's

ability to withdraw borrowed funds for a purpose other than

paying interest.15   Used in this sense, "unrestricted control"

ignores the fact that the borrower may have obligated himself to

use the loan proceeds to pay interest to the lender as a

precondition to the loan, and also ignores the fact that failure

to use loan proceeds for the purpose of satisfying a current

interest obligation would result in a default and likely

foreclosure proceedings.

     Two Courts of Appeals have rejected this application of an

"unrestricted control" rule.   Wilkerson v. Commissioner, 

      We found as a fact that the partnerships had "unrestricted
physical control" over the loan advances when they were deposited
to the partnerships' accounts. Wilkerson v. 

at 244, 249.
                                - 18 -

980 (9th Cir. 1981); Battelstein v. IRS, 

(5th Cir.

1980)(en banc).16    In Battelstein, the lender agreed to make

advances to cover the taxpayers' quarterly interest payments on a

$3 million loan.    The taxpayers never paid interest except by way

of these advances.    The lender notified the taxpayers each

quarter of the amount of interest that was due; the taxpayers

would then send a check for this amount, and the lender would

send the taxpayers a check for an identical amount.

     The Court of Appeals for the Fifth Circuit concluded that

the check exchanges between the lender and borrower were plainly

for no purpose other than to finance the taxpayers' current

interest obligations and, therefore, denied the interest

deduction.   In rejecting the taxpayers' reliance on the fact that

actual checks were exchanged, the Court of Appeals stated:


     16
      In addition, judges of two other Courts of Appeals,
although not faced with the issue, have, in dicta, criticized our
application of the rule. See Burck v. Commissioner, 

(2d Cir. 1976); Goodstein v. Commissioner, 

(1st Cir.
1959), affg. 

(1958). In Burck v. 

, the Court of Appeals for the Second Circuit affirmed our
decision, but it did not consider the issue presented here. In a
portion of the opinion where he was writing "for himself only",
Judge Oakes noted that he disagreed with our decision permitting
an interest deduction. 

n.3. Judge Oakes viewed the
transaction at issue "as having the effect of creating a
'discounted loan,'" and he concluded "that there was no payment
of interest by taxpayer within the meaning of 26 U.S.C. § 163(a)
until actual repayment of the loan." 

further
noted his agreement with the dissenting opinion in Burgess v.
Commissioner, 

(1947). Id.; see also Goodstein v.

at 131 (noting in dicta that it considers the
reasoning of the dissent in Burgess v. 

, to be
the "more persuasive").
                             - 19 -


     In ignoring these exchanges, we merely follow a well-
     established principle of law, viz., that in tax cases
     it is axiomatic that we look through the form in which
     the taxpayer has cloaked a transaction to the substance
     of the transaction. See, e.g., Republic Petroleum
     Corp. v. United States, 

, 524 (5th Cir.
     1980); Redwing Carriers, Inc. v. Tomlinson, 

, 657 (5th Cir. 1968) (citing cases). As the
     Supreme Court stated some years ago in Minnesota Tea
     Co. v. Helvering, 

, 

, 

(1938), "A given result at the end of a straight
     path is not made a different result because reached by
     following a devious 

, 58 S. Ct.
     at 394. The check exchanges notwithstanding, the
     Battelsteins satisfied their interest obligations to
     Gibraltar by giving Gibraltar notes promising future
     payment. The law leaves no doubt that such a surrender
     of notes does not constitute payment for tax purposes
     entitling a taxpayer to a deduction. [Id. at 1184.]


     The Court of Appeals rejected the taxpayers' reliance on

Burgess v. Commissioner, 

(1947).   The Court of Appeals

determined that even if Burgess constituted good law, it was

limited to cases where the purpose of a subsequent loan was not

apparent (i.e., whether it was to finance interest payments on a

previous loan for which deductions are being claimed, or whether

it was to fulfill some other unrelated objective).   The Court of

Appeals held that "If the second loan was for the purpose of

financing the interest due on the first loan, then the taxpayer's

interest obligation on the first loan has not been paid as

Section 163(a) requires; it has merely been postponed."

Battelstein v. 

at 1184.

     In Wilkerson v. 

, the Court of

Appeals relied on Battelstein v. 

, and denied the
                                 - 20 -

interest deduction, because a portion of the loan proceeds was

"specifically earmarked" for the purpose of paying the interest

due.    The Court of Appeals stated that "The fact that the loan

proceeds were run through the taxpayers' bank account in a

transaction intended to take not more than one business day, does

not affect the substance of the transaction."         Wilkerson v.

at 983.      Moreover, the Court of Appeals

explained that "A careful reading of Burgess v. Commissioner, 

(1947), indicates that it involved two separate loan

transactions in which the proceeds of the second loan were not

earmarked for the purpose of payment of interest on the first

loan."      

the reversal in Wilkerson v. 

, we acknowledged the confusion in this area brought about

by the disparity of results among cases of similar economic

impact.      Menz v. Commissioner, 

.    In Menz, we

summarized this Court's previous application of the "unrestricted

control" test as follows:


       Where a lender gives up control of borrowed funds, the
       funds are commingled with the taxpayer's other funds in
       an account at an institution separate from the lender,
       and the interest obligation is satisfied with funds
       from that separate account, there has been a payment of
       interest under section 163(a). * * * [Id. at 1187;
       citations omitted.17]

       17
      Despite this test for determining "unrestricted control",
consideration of the borrower's purpose for acquiring the
                                                   (continued...)
                              - 21 -


In Menz, we found that the taxpayer had not received unrestricted

control over the funds borrowed for the purpose of paying

interest.   We based this conclusion on the following facts:    (1)

The loan to the borrower, the deposit into the borrower's

checking account, and the retransfer of the funds to the lender

were all simultaneous; (2) the remaining funds in the borrower's

account with which it could have paid the interest in question

were de minimis; (3) the loans were made solely for the purpose

of paying the interest owed to the lender; (4) the borrowed funds

were easily traceable through the borrower's account to the

asserted interest payments; and (5) a wholly owned subsidiary of

the lender was a 1-percent general partner of the borrower and

possessed approval power over all the borrower's major

transactions.   The fifth factor is the only one that was not

present in Wilkerson.

     The 1-percent partner did not have signatory authority over

the bank account into which the borrowed funds were deposited.

Menz v. 

at 1190.   Nevertheless, we found that

the borrower lacked "unrestricted control", because the 1-percent

general partner of the borrower was controlled by the lender and

could have terminated the borrower's existence if it had failed

to use the borrowed funds to satisfy interest obligations owed to

     17
      (...continued)
additional funds was never completely disregarded.   See Menz v.
Commissioner, 

, 1187 n.16 (1983).
                                 - 22 -

the lender.     We found that the 1-percent partner's control over

the future of the partnership was too fundamental and significant

to conclude that the partnership's control over the funds in its

account was unrestricted.     

     We think that similar fundamental and significant factors

restricted White Tail's control over the $1,587,310.46 that John

Hancock wired to White Tail's account on December 30, 1980.

White Tail had specifically agreed to borrow this amount to

satisfy its interest obligation in order to prevent a default.

Use of the funds for any other purpose would have breached the

terms of its agreement with John Hancock and would have resulted

in White Tail's default and a likely end to its business

operations.18    In Wilkerson, we chose not to consider the impact

of a default and its consequences on whether the borrower had

unrestricted control over funds that it borrowed.19     See

Wilkerson v. Commissioner, 

.     However, in Menz,

     18
      The existence of such an agreement has been held to
restrict the borrower's control over borrowed funds. See Franco
v. Commissioner, T.C. Memo. 1992-577.
     19
          As we stated in Menz v. Commissioner, 

-
1192:

     we chose not to address what impact a default would
     have had, and found as fact that the borrower had been
     given "unrestricted physical control over the loan
     advance at the time it was deposited in the
     [borrower's] account." 

. On that basis,
     we held that the taxpayer's situation in Wilkerson was
     not meaningfully distinguishable from the Burgess and
     Burck cases and found that there had been the requisite
     "payment" of interest.
                              - 23 -

we expanded our analysis and considered factors beyond physical

control over the borrowed funds.   Similarly, in this case, we

cannot ignore the reality that a borrower who borrows funds for

the purpose of satisfying an interest obligation to the same

lender in order to avoid a default does not have unrestricted

control over the borrowed funds in any meaningful sense.    In

light of our expanded view of the considerations that must be

taken into account in determining whether a borrower has

unrestricted control over borrowed funds, our earlier opinions in

Burgess, Burck, and Wilkerson, have been sapped of much of their

vitality.20

     The issue before us arises when a borrower borrows funds

from a lender and immediately satisfies an interest obligation to

the same lender.   In order to determine whether interest has been

paid or merely deferred, it is first necessary to determine

whether the borrowed funds were, in substance, the same funds

used to satisfy the interest obligation.   Whether the relevant

transactions were simultaneous, whether the borrower had other

funds in his account to pay interest, whether the funds are

traceable, and whether the borrower had any realistic choice to

use the borrowed funds for any other purpose would all be


     20
      Recent opinions indicate that an expanded "unrestricted
control" test will likely produce the same result as the test
applied in the Fifth and Ninth Circuit Courts of Appeals. See
Alexander v. Commissioner, T.C. Memo. 1995-334; Blumeyer v.
Commissioner, T.C. Memo. 1992-647; Franco v. 

.
                              - 24 -

relevant to this issue.   Once it is determined that the borrowed

funds were the same funds used to satisfy the interest

obligation, the purpose of the loan plays a decisive role.

     In light of the foregoing analysis, we hold that a cash

basis borrower is not entitled to an interest deduction where the

funds used to satisfy the interest obligation were borrowed for

that purpose from the same lender to whom the interest was owed.

This test is consistent with our traditional approach of

characterizing transactions on a substance-over-form basis by

looking at the economic realities of the transaction.    We agree

with the Courts of Appeals in Wilkerson and Battelstein that

there is no substantive difference between a situation where a

borrower satisfies a current interest obligation by simply

assuming a greater debt to the same lender and one where the

borrower and lender exchange checks pursuant to a plan whose net

result is identical to that in the first situation.   In both

situations, the borrower has simply increased his debt to the

lender by the amount of interest.   The effect of this is to

postpone, rather than pay, the interest.

     In the instant case, it is clear that the purpose of the

$1,587,310.46 advance on December 30, 1980, from John Hancock to

White Tail was to provide White Tail with funds to satisfy its

interest obligation to John Hancock.   White Tail's general

partner had requested modification of the original 1980 credit

arrangement so that the entire amount of interest could be
                                - 25 -

borrowed from John Hancock, in order to prevent a default on the

interest obligation.    In the Letter Agreement between White Tail

and John Hancock, both borrower and lender agreed that the

$1,587,310.46 advance would increase White Tail's loan and that

it would be used to satisfy the current interest obligation.

Checks were exchanged within a 2-day period to effect the

transaction.    The effect was to increase the amount of White

Tail's principal loan obligation to John Hancock by the amount of

interest due.    The fact that the loan proceeds were run through

White Tail's bank account does not affect the substance of the

transaction.    Wilkerson v. 

.    It

follows that White Tail, a cash basis partnership, is not

entitled to a deduction for interest paid.

     The other transaction in issue also involves a situation

where an interest obligation was satisfied by borrowing funds

from the original lender.    On May 7, 1980, following the

establishment of the 1980 credit arrangement, John Hancock

advanced $19,645,000 to White Tail.      Of this amount, John Hancock

applied $227,647.22 to unpaid interest owed under the terms of a

previous loan to White Tail.     John Hancock did this by crediting

White Tail's prior loan account to show that White Tail's

interest obligation in the amount of $227,647.22 had been

satisfied.     John Hancock simultaneously increased the principal

amount due from White Tail under the new 1980 credit arrangement.
                              - 26 -

     As stated above, we hold that interest is not deductible

under the cash method of accounting where the funds used to

satisfy the interest obligation were borrowed for that purpose

from the same lender to whom the interest obligation was owed.

That is clearly what happened on May 7, 1980, when, pursuant to

the terms of the 1980 credit arrangement, John Hancock credited

White Tail's prior loan account for interest due and

simultaneously increased the principal due on White Tail's new

loan for the same amount.

     Petitioners argue that the $227,647.22 should be considered

as interest "paid", because the 1980 credit arrangement and the

1979 loan from John Hancock were "bona fide separate loans, with

different interest rates and terms, and different security

arrangements."   Under our holding, the fact that funds used to

satisfy an interest obligation to a lender are borrowed from the

same lender in a second loan is irrelevant.   Indeed, this Court

has previously rejected the argument presented by petitioners.

In Cleaver v. Commissioner, 

, we stated:


     where a taxpayer on the cash basis who is indebted on a
     note for past due interest borrows from his creditor an
     amount in excess of this past due interest on a second
     note, and the creditor gives to the taxpayer the
     principal amount of the second note less the amount of
     past due interest on the first note and marks this
     interest "paid," we have held that no cash payment has
     been made which would warrant a deduction.
                              - 27 -

See also Nat Harrison Associates, Inc. v. 

.   Interest withheld by a lender from loan proceeds is

nothing more than a promise to pay in the future and does not

constitute a payment for purposes of section 163(a).   Menz v.

Commissioner, 

; Rubnitz v. Commissioner, 

, 628 (1977); Cleaver v. 

at 454.

     Based on the foregoing analysis, the interest deductions

claimed by White Tail on its 1980 return in the amounts of

$1,587,310.46 and $227,647.22 are not allowable, and we sustain

respondent's disallowance of the corresponding deductions that

petitioners claimed as their distributive share of partnership

loss.



                                         Decision will be entered

                                    under Rule 155.