T.C. Memo. 1997-124



                       UNITED STATES TAX COURT



 CHARLOTTE AIRCRAFT CORPORATION AND SUBSIDIARIES, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2582-96.                       Filed March 11, 1997.



     G. Edward Hinshaw, Jr. and W. Curtis Elliott, Jr., for

petitioner.

     Frank C. McClanahan III, for respondent.


                         MEMORANDUM OPINION


     HAMBLEN, Judge:    This matter is before the Court on

petitioner's motion for partial summary judgment.    Unless

otherwise indicated, all section references are to the Internal

Revenue Code in effect for the taxable years at issue, and all

Rule references are to the Tax Court Rules of Practice and
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Procedure.   In the notice of deficiency, respondent determined

deficiencies in petitioner's Federal income tax in the following

amounts:

           Taxable Years
           Ending Sept. 30             Deficiency


                1987                    $175,870
                1988                      17,909
                1989                      15,048
                1990                     187,808
                1991                     289,879
                1992                      15,402

     The issue on which petitioner has moved for partial summary

judgment is whether petitioner is entitled to deductions for

interest pursuant to section 163 for taxable years ending

September 30, 1990, through September 30, 1992.

     Pursuant to Rule 121, petitioner filed an affidavit with

exhibits in support of its motion for partial summary judgment.

Respondent filed a written response with an affidavit and

exhibits opposing petitioner's motion.

     Rule 121(b) provides that a motion for summary judgment is

to be granted if “there is no genuine issue as to any material

fact and * * * a decision may be rendered as a matter of law.”

The disposition of a motion for summary judgment under Rule

121(b) is controlled by the following principles:   (a) The moving

party must show the absence of dispute as to any material fact

and that a decision may be rendered as a matter of law; (b) the

factual materials and the inferences to be drawn from them must
                                 - 3 -

be viewed in the light most favorable to the party opposing the

motion; and (c) the party opposing the motion cannot rest upon

mere allegations or denials but must set forth specific facts

showing there is a genuine issue for trial.   O'Neal v.

Commissioner, 

, 674 (1994).

     A motion for summary judgment will be granted if the Court

is satisfied that no real factual controversy is present so that

the remedy can serve "'its salutary purpose in avoiding a

useless, expensive and time consuming trial where there is no

genuine, material fact issue to be tried.'"   Casanova Co. v.

Commissioner, 

, 217 (1986) (quoting Lyons v. Board of

Educ., 

, 347 (8th Cir. 1975)).

     Solely for the purposes of disposing of petitioner's motion,

we set forth a summary of the facts relevant to our discussion.

Rule 121(b); Sundstrand Corp. v. Commissioner, 

, 520

(1992), affd. 

(7th Cir. 1994).

     Charlotte Aircraft Corp. (CAC) is a corporation which was

duly formed under the laws of the State of North Carolina in or

about September 1953, for the purpose of buying and selling

transport category aircraft, aircraft engines, and aircraft

parts.   In 1986, CAC formed Caldwell Aircraft Trading Co. (CATCO)

as a wholly owned subsidiary to buy, sell, lease, and broker

aircraft and aircraft engines.

     CATCO contacted Security Pacific Equipment Leasing, Inc.

(SPELI), a subsidiary of Security Pacific Bank.   SPELI had
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experience in the leasing and financing of fleets of aircraft.

CATCO and American Airlines (American) agreed that CATCO would

purchase from American 36 Boeing Model 727-023 aircraft, each

with 3 Pratt & Whitney JT8D-7B turbofan engines (36 aircraft),

and executed a letter of intent, dated April 6, 1990, and an

aircraft purchase agreement, dated June 8, 1990.   The purchase

price per aircraft was $733,333.33, and the aggregate purchase

price was $26,400,000.   At the time of the agreement, the fair

market value of an average Boeing 727-023 was $2 million, and the

cost of a "D" check, a very extensive routine maintenance check,

was $1.2 million.

     CATCO executed a secured promissory note, dated June 27,

1990, with SPELI for the entire purchase price.    The promissory

note provided for repayment of the loan, with interest at a rate

of 12 percent per annum, in 16 installments due on the following

dates:

         Due Dates             Principal Payment

           9/1/92                 $733,333.33
          10/1/92                  733,333.33
           1/1/93                1,466,666.67
           2/1/93                1,466,666.67
           3/1/93                1,466,666.67
           8/1/93                1,466,666.67
           9/1/93                2,933,333.32
          10/1/93                1,466,666.67
          11/1/93                1,466,666.67
           1/1/94                1,466,666.67
           2/1/94                  733,333.33
           3/1/94                1,466,666.67
           9/1/94                2,199,999.99
          10/1/94                2,933,333.34
          11/1/94                2,933,333.32
           1/1/95                1,466,666.68
                                 - 5 -

     As a condition to entering the transaction, SPELI required

CATCO and CAC to enter into a remarketing agreement, an

assignment agreement, and a lease with American.   The remarketing

agreement provided that in the event that CATCO was unsuccessful

in selling the aircraft prior to delivery from American, SPELI

could require CATCO to transfer one or more aircraft to CAC for

the disassembly and sale of the aircraft and parts.   SPELI also

required CAC to assume the debt attributable to such aircraft

when it acquired an aircraft to disassemble.   Using its best

efforts, CAC agreed to sell the disassembled parts at not less

than 25 percent below CAC's estimated price for such a part.    If

SPELI did not accept CAC's estimated prices, its only contractual

remedy was to terminate the remarketing agreement, leaving CAC

with no further liability.   The remarketing agreement also

provided for the allocation of the proceeds between the parties

from the sale of any aircraft or parts.   The remarketing

agreement first allocated the proceeds to the amounts due under

the promissory note, with any excess allocated 55 percent to

CATCO and 45 percent to SPELI.    The assignment agreement required

CATCO to assign all of its rights under the aircraft purchase

agreement as security to SPELI.

     The lease agreement provided for CATCO to lease the 36

aircraft to American for the remaining period of use in

accordance with American's "phase-out" schedule for each

aircraft.   The lease contained a lease rate of $1 per month per
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aircraft.   CATCO and CAC did not consider the economic realities

of the transaction to be those of a lease, and no provision was

made for the fair rental value of the aircraft, which was $60,000

per month per aircraft.    CATCO and American entered the lease

agreement on June 8, 1990.    American actually paid $1,000 in rent

for all 36 aircraft.

     CATCO did not pay the first installment payment due

September 1, 1992.    SPELI notified CATCO by telephone and by

letter that CATCO was in default and demanded payment of the

principal, interest, and late charges then due.    CATCO continued

to look for potential buyers or lessees for the aircraft.

     During that time, the U.S. Postal Service awarded a contract

to Postal Air, Inc. (Postal Air).    CATCO and Postal Air entered

into a sales agreement in which Postal Air agreed to purchase 16

of the 36 aircraft from CATCO for a total purchase price of

$17,600,000.   The day after CATCO signed the contract with Postal

Air, Emery Worldwide Airlines, Inc. (Emery), sought and was

granted a preliminary injunction preventing Postal Air and the

U.S. Postal Service from performing their contract.

     The litigation between Emery and Postal Air was settled in

March 1993.    As part of the settlement, Emery agreed to assist

Postal Air in meeting its obligations to CATCO.    The settlement

agreement, dated March 28, 1993, required Emery to purchase eight

aircraft from CATCO for a total purchase price of $8,800,000 and
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to make an additional $3 million for CATCO's expenses (Emery

settlement).

     On April 14, 1993, SPELI again notified CATCO of its failure

to make the installment payments.    On April 15, 1993, SPELI

notified CATCO that it was declaring the note to be immediately

due and payable for the unpaid balance of principal, interest and

late charges in the amount of $36,505,715.15

     On April 23, 1993, CATCO paid $11,318,575.52 to SPELI from

the proceeds of the settlement with Emery.    A dispute arose

regarding whether this payment made CATCO current under the terms

of their agreement.    On June 4, 1993, SPELI notified CATCO that

it would thereafter exercise CATCO's rights under the lease with

American.

     CATCO failed to make the installment payment due September

1, 1993.    On that same day, SPELI again demanded payment from

CATCO.   On September 7, 1993, SPELI, CATCO, and CAC entered into

a settlement agreement in which CATCO conveyed the remaining

aircraft to SPELI in exchange for satisfaction of the balance of

payments due to SPELI.    Under the agreement, SPELI permitted

CATCO to retain $500,000 of the proceeds from the prior

settlement agreement between CATCO and Emery.

     On its consolidated Federal income tax returns for taxable

years ending September 30, 1989, through September 30, 1992,

respectively, CAC reported that CATCO's liabilities exceeded its
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assets by the following amounts:    $885,712, $1,583,164,

$5,101,295, $9,045,475.

     Petitioner deducted $763,869, $3,354,061, $3,667,803, and

$3,514,267 as interest in its consolidated Federal income tax

returns for taxable years ending September 30, 1990, through

September 30, 1993, respectively.    In the notice of deficiency,

respondent disallowed these interest deductions in total.

     For the reasons stated below, we agree with respondent that

there are genuine issues of material fact in the instant case and

consequently will deny petitioner's motion for partial summary

judgment.

     Section 163 provides that there shall be allowed as a

deduction all interest paid or accrued within the taxable year on

indebtedness.   In order to be deductible, interest must be paid

on genuine indebtedness.   Knetsch v. United States, 

(1960).

     The "all events" test governs whether an accrual of an

expense, including interest, is proper.    See United States v.

General Dynamics Corp., 

, 242 (1987).    Section

461(h)(4) describes the “all events” test as follows:

     All events test.--For purposes of this subsection, the
     all events test is met with respect to any item if all
     events have occurred which determine the fact of
     liability and the amount of such liability can be
     determined with reasonable accuracy.
                               - 9 -

Section 461(h)(1) modifies the all events test, providing that

“the all events test shall not be treated as met any earlier than

when economic performance with respect to such item occurs”.

Economic performance with respect to interest occurs as the

interest cost economically accrues in accordance with the

principles of relevant provisions of the Code.    Sec. 1.461-4(e),

Income Tax Regs.

     Petitioner presents three basic arguments.   First,

petitioner asserts that the substance of the disputed transaction

is that of a forward purchase contract and a loan.   Second,

petitioner contends that the accrued interest due to SPELI was an

unconditional fixed obligation, which satisfied the all events

test for all the taxable years at issue.   Third, petitioner

argues CATCO's intrinsic ability or inability to satisfy the loan

is irrelevant as to whether the accrued interest is deductible.

     Respondent argues that the underlying substance of the

transaction is in dispute.   Respondent further contends that a

reasonable inference may be drawn from all of the facts available

that the disputed transaction is a "best efforts" consignment

contract with CATCO serving as a sales agent for either SPELI or

American and that the interest represents a sharing of profits on

resale of the aircraft.   Respondent alternatively argues that

even if petitioner is correct, the facts are not sufficiently

well developed to warrant a finding that the all events test is

satisfied.   Respondent further argues CATCO's ability to pay
                              - 10 -

interest is relevant both to determining the true substance of

the transaction and to determining whether petitioner was "at

risk" for purposes of section 465(b)(4).

     We must first address the question of the economic substance

of the transaction.   In support of her contention that the

economic substance of the transaction is in dispute, respondent

directs our attention to the fact that the remarketing agreement

provided for the sharing of profits between SPELI and petitioner

after the principal and interest payments have been made.

Respondent also points out that the remarketing and the

assignment agreements gave SPELI the ability to control CATCO's

possession and custody of the aircraft.    Respondent finally

asserts that petitioner has failed to explain:    (1) Why a

reasonable, prudent taxpayer would purchase with borrowed funds

$26,400,000 in revenue-producing assets, the aircraft, for which

the taxpayer is obligated to begin principal and interest

payments in approximately 2 years yet agree to realize only

$1,000 over the same period from a lease-back agreement; and (2)

why the settlement agreement between SPELI, CAC, and CATCO

permitted CATCO to retain $500,000 of the proceeds from the Emery

settlement even though CATCO was allegedly in default.

     Upon examination of the pleadings, petitioner's motion for

partial summary judgment and the affidavits attached thereto, and

respondent's response and the affidavits attached thereto, we

believe there are genuine issues of material fact critical to the
                               - 11 -

characterization of the transaction herein.    Resolution of

whether a transaction is a loan depends in part on the intent of

the parties.    Litton Bus. Sys. Inc. v. Commissioner, 

,

377 (1973).    The value of a trial with full opportunity to

observe the parties and their evidence is obvious.    This is

especially so when the question of intent is present.     Preece v.

Commissioner, 

(1990); Shiosaki v. Commissioner, 

, 863-864 (1974).    A conclusion as to a taxpayers' intent

should not be reached without the benefit of a trial in which the

demeanor of the witnesses can be observed and their credibility

can be weighed.    Shiosaki v. 

.

     In short, the issue is not ripe for summary adjudication.

Petitioner's claim is, in effect, that the documentation controls

the characterization.    In order to grant petitioner's motion, we

would have to accept petitioner's interpretation of the documents

relating to the transaction, petitioner's understanding of the

transaction as the understanding of all the parties, and

petitioner's explanation of any apparent discrepancies.    By

petitioner's reasoning, Gregory v. Helvering, 

(1935), should have been resolved on a motion for summary

judgment because the paperwork documented a reorganization.     It

is the substance of the transaction and not the form which must

control the consequences for Federal tax purposes.    University

Country Club, Inc. v. Commissioner, 

, 471 (1975).
                             - 12 -

     The resolution of whether the substance of the transaction

at issue is a loan may obviate the necessity of deciding whether

the all events test is satisfied or whether petitioner's ability

to pay interest affects the availability of the deductions.   For

these reasons, we conclude that petitioners' motion for partial

summary judgment must be denied.



                         An appropriate order will be issued.