UNITED STATES TAX COURT



       ROUNTREE COTTON CO., INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 24014-97.                     Filed December 16, 1999.



     R determined that C made below-market-interest
loans directly and indirectly to C’s shareholders
within the meaning of sec. 7872, I.R.C. The “indirect”
loans were to entities owned in part by C’s
shareholders. C contends that sec. 7872, I.R.C., was
not intended to apply to a loan by C to a shareholder
of C who does not have a majority or controlling
interest in C. C also contends that sec. 7872, I.R.C.,
does not apply to a loan by C to an entity in which no
shareholder of C individually holds a controlling or
majority interest. R contends that the below-market-
interest loans to entities were all made indirectly to
C’s shareholders. All of C’s shareholders were members
of the same family, and each of the entities was owned
entirely by members of that family, although some of
them were not shareholders of C. R argues that sec.
7872, I.R.C., does not require that C’s shareholders
have a majority or controlling interest in the entities
                               - 2 -

     to which the “indirect” loans were made in these circumstances.
          C also contends that R cannot make determinations
     with respect to it without making corresponding
     adjustments to the income taxes of its shareholders. R
     argues that such adjustments are not a prerequisite to
     the making of a determination with respect to one of
     the parties to a sec. 7872, I.R.C., below-market-
     interest loan.
          Held: Sec. 7872(c)(1)(C), I.R.C., applies to C’s
     loans to each of its shareholders and to C’s loans to
     each of the family-owned entities in which C’s
     shareholders held an interest. Held, further: Sec.
     7872, I.R.C., requires “consistent” treatment but does
     not require that R make both adjustments concurrently
     or determine one before determining the other.



     Towner Leeper, for petitioner.

     Gerald L. Brantley, for respondent.



                              OPINION

     GERBER, Judge:   Respondent determined income tax

deficiencies in petitioner’s taxable years ended August 31, 1994

and 1995, in the amounts of $19,094 and $16,944, respectively.

The deficiencies are attributable to respondent’s determination

that petitioner made “below-market loans” within the meaning of

section 7872.1   More particularly, we consider a question of

first impression of whether the provisions of section 7872 apply


     1
       All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to
this Court’s Rules of Practice and Procedure, unless otherwise
indicated.
                               - 3 -

where petitioner makes loans to its shareholders and to entities

owned in part by its shareholders and in part by other members of

the same family.

Background

     Petitioner is a corporation that, at all pertinent times,

had its principal place of business in Las Cruces, New Mexico.

Petitioner was engaged in cotton brokerage and, for Federal

income tax purposes, reported gross income of $1,276,431 and

$1,913,962 for its fiscal 1994 and 1995 tax years, respectively.

At all pertinent times, the shares of stock of petitioner were

owned by family members related by blood or marriage as follows:

                                 Ownership
         Shareholders               (%)
        William Tharp              16.8
        Est. of Glenda Tharp       16.7
        Charles Tharp              33.5
        Claudia Keith              33.0
             Total                100.0

William and Charles Tharp and Claudia Keith are all children of

Claud Tharp, who did not own any shares of petitioner.   Glenda

Tharp, now deceased, was the wife of William Tharp.

     During the fiscal years in issue, shareholders of petitioner

and related family members owned or had an interest in certain

entities as follows:   (1) Charles Tharp and his son, Craig Tharp,

each owned a 50-percent interest in the capital and profits of

the Buena Vista Partnership; (2) the Dona Ana Land Corp.’s shares

of stock were owned in the following percentages:   William
                                - 4 -

Tharp--14.5 percent, Charles Tharp--29 percent, Claudia Keith--9

percent, Claud Tharp--33 percent, and the Estate of Glenda

Tharp--14.5 percent; (3) capital and profit interests in the

Tharp Family Partnership were owned, as follows:      William Tharp--

10 percent, Charles Tharp--10 percent, Claudia Keith--10 percent,

and each child of William, Charles, and Claudia owned a 10-

percent interest, accounting for the remaining 70 percent; (4)

capital and profit interests in the Tharp Farms Partnership were

owned as follows:    William Tharp--30 percent, Charles Tharp--30

percent, Claudia Keith--20 percent, Claud Tharp--20 percent; and

(5) capital and profit interests in the Tharp Enterprises

Partnership were owned as follows:      William Tharp--25 percent,

Charles Tharp--25 percent, Claudia Keith--25 percent, and Claud

Tharp--25 percent.    The various interests of petitioner’s

shareholders and of other family members in the entities to which

indirect loans were made are reflected in a chart attached to

this opinion as an appendix.

     The following interest-free loans were made by petitioner

directly to shareholders:

                           Demand Note
        Borrower              Dated               Amount
      Charles Tharp       Aug. 31, 1994         $29,978.74
      William Tharp       Aug. 31, 1994          11,100.00
      William Tharp       Aug. 31, 1994          28,113.21

Respondent’s agent computed interest at the applicable Federal

rate on the loans directly to shareholders in the aggregate
                                - 5 -

amounts of $3,143 and $3,416 for petitioner’s fiscal tax years

ended August 31, 1994 and 1995, respectively.

     The following interest-free loans, evidenced by promissory

notes, were made by petitioner to entities that were, in some

part, owned by petitioner’s shareholders:

                                         Demand Note
      Borrower                              Dated         Amount
Buena Vista Partnership                 Aug. 31, 1994   $27,575.14
Dona Ana Land Corp.                     Aug. 31, 1994    50,412.27
Tharp Family Partnership                Aug. 31, 1994     2,599.12
Tharp Farms Partnership                 Aug. 31, 1994   581,889.39
Tharp Enterprises--Farms1               Aug. 31, 1994   401,855.24
Tharp Enterprises--Equipment1           Aug. 31, 1994    16,200.00
 1
   It appears that these two loans were both made to Tharp
Enterprises Partnership and that the “Farms” and “Equipment”
designations reflected the bank accounts into which they were to
be deposited.

During the taxable years under consideration, an additional

$111,707.20 interest-free loan was extended by petitioner to

Tharp Enterprises Partnership that was not evidenced by a

promissory note.

     Respondent’s agent computed interest at the “applicable

federal rate” on the indirect loans (not directly to

shareholders) in the aggregate amounts of $45,816 and $46,447 for

the fiscal tax years ended August 31, 1994, 1995, respectively.

The total amounts of imputed interest determined by respondent

for petitioner’s 1994 and 1995 fiscal years were $48,959 and
                                - 6 -

$49,836.2    Respondent’s agent’s initial computation and the

amounts set forth in the notice of deficiency were computed on a

fiscal year basis.    A second computation by respondent, submitted

for trial purposes, was based on imputed interest for the 1994

and 1995 calendar years in the aggregate amounts (including

direct and indirect loans) of $19,476 and $59,832, respectively.

Discussion

     I. Procedural/Evidentiary Matter

     This case was submitted fully stipulated by the parties

under Rule 122.    Respondent, however, reserved an objection to

the admissibility (relevance) of Exhibit 17-P, which is

respondent’s revenue agent’s report that was prepared and given

to petitioner before issuance of the notice of deficiency.

Respondent contends that the revenue agent’s report is not

admissible (relevant) in this instance.    In support of his

position, respondent points out that the Court considers the

parties’ positions de novo and the pre-deficiency-notice

administrative record is therefore irrelevant.    See Greenberg’s

Express, Inc. v. Commissioner, 

(1974).    Respondent

acknowledges, however, that in certain limited circumstances, the

Court will “look behind the deficiency notice”.    Such instances


     2
       In the notice of deficiency, respondent determined $49,836
of 1995 interest. The correct amount, however, should have been
$49,863. The transposition of the numbers 3 and 6 caused a $27
difference.
                               - 7 -

include unconstitutional conduct by respondent’s employees, see,

e.g., Riland v. Commissioner, 

(1982), and certain

types of illegal income cases, see, e.g., Shriver v.

Commissioner, 

(1985).     Petitioner does not contend that

respondent’s determination is arbitrary or that unconstitutional

conduct occurred.   We agree with respondent and find no reason to

consider respondent’s agent’s pre-deficiency-notice report in

reaching our decision.   Respondent’s objection is sustained with

respect to proposed Exhibit 17-P.

     II. Section 7872

     The primary question for our consideration concerns whether

petitioner must include interest, pursuant to section 7872,

attributable to interest-free loans made to entities (a

corporation and three partnerships) owned in whole or part by its

shareholders.   Before the enactment of section 7872, the

Commissioner was generally unsuccessful in attempting to

attribute or impute income from interest-free or below-market

loans.3   See Dean v. Commissioner, 

(1961); Greenspun

v. Commissioner, 

(1979), affd. 

(9th Cir.

1982); Suttle v. Commissioner, 

(4th Cir. 1980),

affg. T.C. Memo. 1978-393; Martin v. Commissioner, 

     3
       Respondent, however, was ultimately successful, in a gift
tax context, in situations where below-market loans were made
between family members. See Dickman v. Commissioner, 

(1984).
                               - 8 -

(5th Cir. 1981); Beaton v. Commissioner, 

(1st Cir.

1981), affg. T.C. Memo. 1980-413.

      Congress, in 1984, addressed these and other related

concepts by enacting section 7872.     See Deficit Reduction Act of

1984, Pub. L. 98-369, sec. 172(a), 98 Stat. 699.    That section

concerns the subject of “below-market loans” in several contexts,

including those between family members, partnership/partner,

employer/employee, corporation/shareholder, and other related-

party categories.   We described the general effect of section

7872 in KTA-Tator, Inc. v. Commissioner, 

, 101-102

(1997), as follows:

     Section 7872 sets forth the income and gift tax
     treatment for certain categories of “below market”
     loans (i.e., loans subject to a below-market interest
     rate). Section 7872 recharacterizes a below-market
     loan as an arm’s-length transaction in which the lender
     made a loan to the borrower in exchange for a note
     requiring the payment of interest at a statutory rate.
     As a result, the parties are treated as if the lender
     made a transfer of funds to the borrower, and the
     borrower used these funds to pay interest to the
     lender. The transfer to the borrower is treated as a
     gift, dividend, contribution of capital, payment of
     compensation, or other payment depending on the
     substance of the transaction. The interest payment is
     included in the lender’s income and generally may be
     deducted by the borrower. See H. Conf. Rept. 98-861,
     at 1015 (1984), 1984-3 C.B. (Vol. 2) 1, 269; Staff of
     Joint Comm. on Taxation, General Explanation of the
     Revenue Provisions of the Deficit Reduction Act of
     1984, at 528-529 (J. Comm. Print 1984).

     Petitioner advances several arguments in support of its

overall contention that the loans it made do not come within the

provisions of section 7872.   Petitioner contends that it has
                               - 9 -

suffered by the Government’s 15-year failure to issue final

regulations, although Congress, in the 1984 statute, mandated

that certain legislative regulations be promulgated.    Petitioner

also contends that case precedent, before the 1984 enactment of

section 7872, established that imputed interest should apply to a

loan by a corporation only if the loan is to a sole or

controlling shareholder.   In addition, petitioner contends that

section 7872 legislative history supports its contention that the

section is limited to situations involving controlling

shareholders.

     The below-market loan provisions of section 7872 apply,

among other circumstances, to “Any below-market loan directly or

indirectly between a corporation and any shareholder of such

corporation.”   Sec. 7872(c)(1)(C).    In that respect, petitioner

reads section 7872 as referring to a loan by a corporation to its

majority or controlling shareholder or to a loan by a corporation

to an entity in which one of the lending corporation’s

shareholders owns a majority interest.    Petitioner relies on the

fact, in this case, that there is no one individual with a

majority of its shares or who is a controlling shareholder of

petitioner.   Petitioner also relies on the fact that no

individual shareholder of petitioner had a majority or

controlling interest in any of the entities to which “indirect”
                              - 10 -

loans were made.   We consider each of petitioner’s contentions

separately.

     The Failure To Issue Final Regulations--Petitioner contends

that the Government’s failure, for almost 15 years, to issue

final or permanent regulations as mandated by Congress in section

7872(h)(1) was to petitioner’s detriment.4   That section contains

the requirement that the Secretary prescribe regulations in

several broad areas, including for the

     purpose of assuring that the positions of the borrower
     and lender are consistent as to the application (or
     nonapplication) of * * * [section 7872] and * * *
     exempting * * * transactions the interest arrangements
     of which have no significant effect on any Federal tax
     liability of the lender or the borrower.

Sec. 7872(h)(1)(B) and (C).   Petitioner contends that if final

regulations had been promulgated, it would have been to its

benefit.   Petitioner, however, has not identified any particular

benefit that would have been conferred, the substance of any

regulations envisioned by petitioner, or the reason(s) for such

regulations.

     The Commissioner, during 1985 and before the time the loans

herein were made, published proposed regulations.   See secs.


     4
       Petitioner’s argument is obscure in that no explanation is
provided as to how the issuance of the final regulations would
have provided a better situation for petitioner or changed the
outcome of this case. It is more likely than not that
respondent’s litigating position and regulation(s) would have
been equivalents. Petitioner’s concern about the absence of
final regulations is also less compelling where, as here, some
guidance was provided by the issuance of proposed regulations.
                              - 11 -

1.7872-1 through 1.7872-13, Proposed Income Tax Regs., 50 Fed.

Reg. 33556-33569 (Aug. 20, 1985).   The Commissioner also

published one temporary regulation.    See sec. 1.7872-5T,

Temporary Income Tax Regs., 50 Fed. Reg. 33521 (Aug. 20, 1985).

Petitioner contends that the proposed regulations do not have the

force and effect of law and are not to be given any more

deference than respondent’s litigating position, citing KTA-

Tator, Inc. v. Commissioner, supra at 102-103.

     The proposed regulations did provide taxpayers with guidance

as to the Commissioner’s section 7872 position regarding certain

aspects of the issues in this case and the broad areas Congress

mandated for legislative regulations.    We note that the proposed

and temporary regulations were published substantially in advance

of the making of the loans in question.    In that regard, the

Commissioner’s proposed and temporary regulations contain

exemptions from section 7872, de minimis rules, and

interpretations and rules regarding below-market loans.      The

proposed and temporary regulations are generally unfavorable to

petitioner’s position.   Accordingly, if the Commissioner had

converted the proposed regulations to final or permanent status,

it would not have been beneficial to petitioner or its

shareholders.

     Respondent has scrupulously avoided reliance upon or

reference to the proposed regulations.    In response to
                                - 12 -

petitioner’s complaint about the absence of final regulations,

respondent argues that the statute is clear and unambiguous

concerning the issues before the Court and that there is no need

to seek interpretation or guidance from any regulation.    In

addition, respondent contends that the section 7872(h) areas for

which regulations were mandated and which were referenced by

petitioner have no bearing on the questions before the Court.

     We first consider the statutory language in our search for

an answer.    See United States v. American Trucking Associations,

Inc., 

, 542-543 (1940); Hospital Corp. of Am. v.

Commissioner, 

, 128 (1996).    If the language of the

statute is clear, we need look no further in deciding its

meaning.     See Sullivan v. Stroop, 

, 482 (1990).

     Petitioner’s Controlling Shareholder Argument--Below-market

loans between corporations and shareholders may come within the

provision of section 7872.    In particular, section 7872(c)(1)(C)

makes section 7872 applicable to “Any below-market loan directly

or indirectly between a corporation and any shareholder of such

corporation.”    The loans in question were without interest, and,

if the other threshold requirements are met, the loans would be

subject to section 7872.

     Petitioner’s primary attack on respondent’s determination is

based on the fact that each of its shareholders has less than a

majority or controlling interest in petitioner and that the
                               - 13 -

entities to which petitioner made (indirect) loans were not owned

entirely by petitioner’s shareholders.    In support of its

approach, petitioner first focuses on the statutory language.

Petitioner argues that the singular use of the term “shareholder”

in the phrase “between a corporation and any shareholder” is

intended to reflect that attribution rules do not apply.

Respondent’s counsel, for the record, states that there was no

reliance on the attribution rules of sections 267 and 318 in this

case.   Section 7872 does not require that a corporate loan be

made to a controlling or majority shareholder.    The statutory use

of the term “any” preceding the term “shareholder” would obviate

the need for respondent to rely on attribution rules for

application of section 7872 in connection with a transaction with

a minority shareholder.    Petitioner’s argument concerning the

loans made directly to its shareholders is refuted by the plain

language of the statute.

     As to the “indirect” loans, respondent’s argument is that

petitioner’s shareholders are members of the same family and that

they, along with other family members, own the entities to which

indirect loans were made.    In that regard, Claud Tharp (father of

three of petitioner’s shareholders and father-in-law of the

fourth) is the only nonshareholder with a substantial interest in

the two entities to which the vast majority of the indirect loans

were extended.
                              - 14 -

     Petitioner also argues that court holdings addressing

“below-market loans” fact patterns, both before and after the

enactment of section 7872, concerned majority or controlling

shareholders.   Petitioner concludes that these cases, therefore,

stand for the proposition that without control by a shareholder

there can be no imputed interest.   On that point, however,

insofar as it pertains to the loans made directly to petitioner’s

shareholders, the terms of section 7872(c)(1)(C) are clear; i.e.,

it applies to loans “between a corporation and any shareholder”

(emphasis added).   Again, there is no ambiguity or room for

interpretation of the statutory language regarding its

application to shareholders who are not controlling or majority

shareholders.   It appears, to some extent, that section 7872 was

enacted in response to the cases that petitioner has relied upon

and in which the Commissioner was generally unsuccessful in

pursuing below-market loan situations.

     In addition, the pre- and post-enactment opinions, although

they involve controlling shareholder fact patterns, do not

reflect any consideration of a threshold requirement that below-

market loans be made to a majority shareholder.5   Finally,



     5
       To the contrary, the Commissioner was unsuccessful in the
corporation/shareholder cases for reasons that had no
relationship to the number of shares held by the taxpayer.
Although share ownership may have some relationship to dividend
and constructive dividend situations, that aspect was not focused
upon in the line of cases referenced by petitioner.
                              - 15 -

petitioner did not provide a reason why Congress would have

intended that the provisions of section 7872 be limited to loans

made to a majority shareholder.   To the contrary, it appears that

Congress did not intend to limit the focus of section 7872 to

loan transactions between controlled entities.   Section 7872

addresses below-market loans in several settings where there is

no ownership or control factor whatsoever; i.e., employer/

employee and independent contractor/client.   The intent and

context of section 7872 is not limited to situations where there

is control between the lender and the borrower or control over

the ultimate borrowing entity in “indirect” loan situations.

This general absence of a control requirement is bolstered by the

specific language of section 7872(c)(1)(C) causing the statute to

apply to “any shareholder”.

     Petitioner also refers to a portion of H. Conf. Rept. 98-861

(1984), 1984-3 C.B. (Vol. 2) 1 (legislative history for section

7872), in support of its position that Congress intended to limit

corporate section 7872 loans to situations involving controlling

shareholders.   As part of a paragraph explaining   “Family loans

and non-family demand loans”, the House report contains the

following statement:

     In the case of a demand loan from a closely held
     corporation to a controlling shareholder, the transfer
     would be treated as a distribution with respect to the
     stock of the distributing corporation and be taxed to
     the shareholder as a dividend to the extent of the
                               - 16 -

       distributing corporation’s earnings and profits under
       section 301.

H. Conf. Rept. 98-861, supra at 1013, 1984-3 C.B. (Vol. 2) at

267.

       Petitioner’s quotation from the House report is not

compelling because it is taken out of context and appears to be

an example of the application of section 7872 in a corporate

setting involving a demand note.    The above-quoted House report

language is not designed to limit the application of section 7872

to situations involving controlling shareholders.    The reference

to “a controlling shareholder” may also relate to the

corresponding “dividend” mentioned later in the quoted sentence.

More importantly, the statutory language “any shareholder” is

clear, without limitation, and unambiguous, and there is no need

to seek out the legislative intent in the underlying legislative

history.    The portion of the legislative history relied on by

petitioner is also far from being directly on point or probative

in support of petitioner’s position.     Accordingly, we hold that

section 7872 may apply to a loan to a majority or a minority

shareholder.

       Petitioner’s Indirect Loan Argument--We next consider

petitioner’s arguments that section 7872 should not apply to the

“indirect loan” situations.    Petitioner declares that 7 of the 10

loans in question were “indirect” (not made directly to

shareholders) and do not come within the purview of section 7872.
                              - 17 -

More particularly, petitioner contends that the “indirect loans”

were made by petitioner to partnerships or entities in which none

of petitioner’s shareholders individually held a controlling

interest.   Finally, petitioner points out that some of the

partners or owners of the entities that received loans were not

shareholders of petitioner.

     The specific concern raised by petitioner’s arguments

focuses upon petitioner’s shareholders’ partial interest in the

entity that receives the benefit of the below-market loan and in

the receiving entity.   Although the borrowing entity receives the

full benefit of the indirect loan, petitioner’s shareholder(s)

are each only partially benefited by the loan because of their

less than complete ownership of the borrowing entity.       An adjunct

question concerns the treatment of a nonshareholder of petitioner

who may be benefited because of his ownership interest in the

borrowing entity.

     The statute includes “Any below-market loan directly or

indirectly between a corporation and any shareholder of such

corporation.”   Sec. 7872(c)(1)(C).    Indirect loans are

includable, but the statute does not specifically address the

possibility that indirect loans may ultimately benefit a person

or entity other than a shareholder or that the shareholder may

ultimately receive less benefit than the full amount lent.      The

proposed regulations generally address indirect loans by
                              - 18 -

     [restructuring them] as two or more successive below-
     market loans (“deemed loans”) * * *, as follows:

          (i) A deemed below-market loan made by the named
     lender to the indirect participant [e.g., a shareholder
     of the lender]; and

          (ii) A deemed below-market loan made by the
     indirect participant to the borrower [third party or
     nonshareholder].

Sec. 1.7872-4(g)(1)(i) and (ii), Proposed Income Tax Regs., 50

Fed. Reg. 33561 (Aug. 20, 1985).   Where one corporation makes a

loan to another under common control, the proposed regulations

restructure it as a loan from the lending corporation to its

parent followed by a loan from the parent to the borrowing

entity.   Thus the proposed regulations treat the entire loan as

being made first to the shareholder(s) of the lender.

     The proposed regulations do not directly address the

questions, raised by petitioner, concerning whether a

nonshareholder would be subject to section 7872 under the facts

before us or how the nonshareholder would be treated in

connection with any benefit received from the receipt of a below-

market loan by the borrowing entity.6   Although those questions

are raised and argued by petitioner, we do not have before us



     6
       The remainder of the proposed regulations concerning
indirect loans contains some examples and focuses on the
following situations: (1) Applying sec. 7872 separately to each
deemed loan, and (2) dealing with circumstances where
intermediaries are used to “avoid the application of section
7872(c)(1)(A), (B), or (C)”. Sec. 1.7872-4g(2), Proposed Income
Tax Regs., 50 Fed. Reg. 35561 (Aug. 20, 1985).
                              - 19 -

questions about how the shareholders or nonshareholders are

individually taxed.   Here, we have jurisdiction solely over

whether petitioner, a corporation, is subject to section 7872 and

whether imputed interest arises from the interest-free loans it

made to its shareholders and the related entities.

     Petitioner, however, is contending that distortion is caused

by the application of section 7872 to situations where a

corporation makes loans to an entity in which both shareholders

and nonshareholders of the lending corporation have ownership

interests.   Petitioner explains that Claud Tharp, who owned no

shares in the lending corporation (petitioner), did own 20

percent of the Tharp Farms Partnership and 25 percent of Tharp

Enterprises Partnership, entities that received most of the

proceeds of the indirect below-market loans.   Petitioner’s

argument contains the implication that respondent would be unable

to make dividend income adjustments to all participants in the

entity to which indirect loans are made.   Petitioner theorizes

that respondent’s alleged inability should preclude respondent

from determining that the lending corporation had income

attributable to the below-market interest.   Petitioner’s position

is somewhat myopic because section 7872 is not limited to

transactions between corporations and shareholders.   It may

result in below-market loans being treated in part as gifts,

dividends, contributions of capital, payments of compensation, or
                              - 20 -

some other type of payment, depending on the substance of the

transaction.   Accordingly, there would be no lack of continuity

where an indirect below-market loan was made by a corporation to

an entity that was owned by the lender’s shareholders and

nonshareholders of the borrowing corporation.

     In that same vein, respondent contends that there is no

statutory prerequisite that a corresponding or correlative

adjustment be made to the tax of a hypothetical borrower before

making an adjustment to the tax of the lender.    Although

respondent states that he is able to determine an adjustment with

respect to petitioner’s shareholders, he contends that his

failure to do so would not necessarily preclude a determination

with respect to petitioner’s taxes.    In support of this

contention, respondent relies on an explanation in KTA-Tator,

Inc. v. Commissioner, 

, that dividend income

determined by the Commissioner may be offset by the shareholder’s

interest deductions, but the lending corporation would not be

entitled to a corresponding deduction attributable to the deemed

dividend distribution against its imputed interest income.

Although the holding of KTA-Tator, Inc. has no direct bearing on

the questions involving “indirect” loans, the discussion in that

case illustrates that one party to a below-market loan may end up

with a tax liability, and the other may incur no net tax effect.

That, however, does not specifically focus on the question of
                              - 21 -

what is meant by “consistency” between the lender and the

borrower.

     In section 7872(h)(1)(B), the Secretary was mandated to

prescribe “regulations for the purpose of assuring that the

positions of the borrower and lender are consistent as to the

application (or nonapplication) of this section”.   We do not read

that language as requiring regulations that provide for

correlative or numerically corresponding adjustments between a

lender and a borrower.   We understand that language to call for

regulations that ensure that both parties to the transaction

would or would not be subject to the effect of section 7872.    So,

for example, if it were determined that an employer made a below-

market loan to a nonshareholder employee under section 7872, to

be consistent, the Commissioner would be required to consistently

treat both the employee and the employer as subject to the

provisions of section 7872.   Treating them consistently may

require the Commissioner to permit appropriate deductions to a

party to a loan transaction as though the interest had actually

been paid.   If, however, the Commissioner was barred from

treating one of the parties to the loan consistently because of

the expiration of the period for assessment, that would not
                               - 22 -

preclude the determination of appropriate income or deductions

for a taxpayer whose period for assessment remained open.7

     Petitioner’s argument also raises the adjunct question of

whether respondent’s inability to make adjustments to

nonshareholders of the borrowing entities has any effect on the

application of section 7872.   With respect to these questions,

the statutory language applying section 7872 directly or

indirectly to loans or to any shareholder does appear to answer

questions of whether the statute applies to indirect loans

involving nonshareholders.   This is a situation where the

issuance of final regulations might have been helpful to address

the tax effect of the below-market loans on the recipients, but

the taxability with respect to the lender is adequately set out

in the statute.

     Because section 7872 is to be applied to a loan made

“directly or indirectly” between a corporation and any

shareholder of the corporation, we find the ordering approach

used in the proposed regulations to be an effective way to

address the issue we consider here.     Under the proposed


     7
       The record does not reveal whether respondent made
“consistent” or any determinations with respect to shareholders
or nonshareholders or whether respondent is currently limited in
his ability to do so. Petitioner merely argues, in the abstract,
that respondent should not be permitted to make the determination
in this case without making one for the shareholders or perhaps
others. If respondent has not already done so, we do not believe
that petitioner’s shareholders are inviting respondent to make
deficiency determinations against them under sec. 7872.
                              - 23 -

regulations, indirect loans are treated as from the lender to the

indirect participant and then to the borrower.8   That is one

logical method to determine the effect of the below-market loans

on all the participants and to treat direct and indirect loans

similarly.   In this setting, the loans are being made by a

family-owned corporation indirectly to shareholders through

family-owned entities.   The ability to make such loans depends on

petitioner’s shareholder(s), and so the whole amount of the loan

is first attributable to the shareholders’ relationship with the

lender.   After that point, the flow from the lender’s

shareholders to others, whether partners, nonshareholders, or

some other relationship, would be subject to section 7872 only if

that transaction came within the statutory ambit.   The effect and

handling of any separately hypothecated loans after those

considered to the lender’s shareholders present a more complex

question that would be better addressed in regulations and is one

we need not address here.

     We recognize that there could be some questions about the

amount of any dividend to the shareholder(s) in an indirect loan

situation, especially where the borrowing entity does not



     8
       The proposed regulation restructures indirect loans into
separate loans as follows: “(i) A deemed below-market loan made
by the named lender to the indirect participant; and (ii) A
deemed below-market loan made by the indirect participant to the
borrower.” Sec. 1.7872-4(g)(1)(i) and (ii), Proposed Income Tax
Regs., 50 Fed. Reg. 35561 (Aug. 20, 1985).
                                - 24 -

comprise solely shareholders.    We need not answer those questions

in this setting, however, because we are able to deal with the

entire loan from the corporation to the shareholder within the

statutory framework and without reference to any regulation.    To

the extent that Tharp family members who were not shareholders

received some benefit from the below-market loans, they did so

only because the lender’s shareholders (who were also Tharp

family members) made the decision or choice that they so benefit.

Also, because of our holding on the ordering of the indirect

loans, any benefit received by nonshareholders would have been

received from petitioner’s shareholders.

     Parts of section 7872 (other than the one addressing

corporations and shareholders) concern below-market loans in

several types of situations.    None of the various section 7872

applications addressing below-market loans require that each

dollar lent benefit the intended borrower directly or fully.    We

know this because the statute applies to indirect loans, and, by

definition, such loans can be to a person or entity other than

the shareholder or corporation referenced in section

7872(c)(1)(C).

     Respondent, on brief, argues that “the interest-free demand

loans were made by petitioner to the borrowing entities solely to
                              - 25 -

confer an economic benefit * * * to petitioner’s shareholders,

who also owned and controlled the borrowing entities.”9

     We agree with respondent that the circumstances in this case

are such as Congress intended would trigger the lender’s

recognition of forgone interest under section 7872(c)(1)(C).

Petitioner would have us focus on the fact that no shareholder of

petitioner individually held a majority of petitioner’s stock

and, as to indirect loans, that persons who were not shareholders

of petitioner owned interests in the entities that received the

below-market loans.   Petitioner’s focus, however, overlooks the

fact that all of the shareholders of petitioner were part of the

same family and, of necessity, collectively agreed to make or

permit the making of below-market loans both directly to

themselves and indirectly to their family-controlled entities.

In the same vein, the “indirect borrowing entities” were

exclusively composed of family members, including petitioner’s

shareholders and in some instances the shareholders’ father or

children.

     The below-market loans were being made within a tightly

controlled conglomeration of Tharp family members and entities


     9
       Respondent does not rely on the attribution provisions of
sec. 267 or 318 for his interpretation of the language of sec.
7872. Respondent does, however, ask us to focus on the fact that
petitioner and the entities to which it made loans were all owned
and controlled by persons having a close family relationship. No
ownership interest in any of those entities was held by an
individual outside of the family.
                              - 26 -

for the benefit of Tharp family members, most of whom were

shareholders of petitioner.   This is the type of situation that

section 7872 was intended to address.   In the setting of this

case, if there had been significant ownership of the borrowing

entities by anyone who did not belong to the Tharp family, we do

not think it likely that interest-free loans to those entities

would have been made by petitioner.    In view of the foregoing, we

hold that the direct and indirect loans made by petitioner come

within the provisions of section 7872(c)(1)(C) and that interest

should be imputed to petitioner.

     That does not end our inquiry, however, because respondent,

in the notice of deficiency, computed the amount of interest to

be imputed to petitioner on the basis of the loans outstanding

during each of petitioner’s taxable years.   For tax purposes,

petitioner used a fiscal year ending on August 31.   Petitioner,

however, argues that section 7872 requires an interest

computation based on a calendar year.   Section 7872(a)(2)

provides that

     Except as otherwise provided in regulations prescribed
     by the Secretary, any foregone interest attributable to
     periods during any calendar year shall be treated as
     transferred (and retransferred) under paragraph (1) on
     the last day of such calendar year.

The Commissioner did not publish any final or temporary

regulations that vary from the rule stated in section 7872(a)(2).
                               - 27 -

     The total amounts of imputed interest determined by

respondent for petitioner’s 1994 and 1995 fiscal years were

$48,959 and $49,836, respectively.      In his reply brief,

respondent provides a second computation of imputed interest for

the 1994 and 1995 calendar years in the aggregate amounts

(including interest on both direct and indirect loans) of $19,476

and $59,832, respectively.   In that regard, respondent concedes

in his reply brief that “Forgone interest is treated as

transferred by the borrower to the lender as interest on the last

day of the calendar year.    I.R.C. § 7872(a)(2)”.

     Accordingly, respondent concedes that his notice

determination amounts were not correctly computed.      The proposed

corrected computations result in a substantially reduced interest

amount for petitioner’s 1994 tax year from $48,959 to $19,476 and

an increased interest amount for petitioner’s 1995 tax year from

$49,836 to $59,832.   With respect to respondent’s concessions,
                              - 28 -

 which we accept, we leave the parties to compute the revised

deficiencies, if any, under Rule 155.10

     To reflect the foregoing,

                                     Decision will be entered under

                                 Rule 155.




     10
       To the extent that respondent’s revised 1995 computation
of interest is greater than the amount determined in the notice
of deficiency, respondent is limited by the amount of corporate
income tax deficiency determined in the notice because of the
timing of the concession (by means of reply brief) and because
respondent has not sought to amend his answer and to assert an
increased deficiency under sec. 6214.
                                                    - 29 -

                                                                                         APPENDIX
                                    Summary of Ownership Interests


                       Ownership Interests in Rountree Cotton Co., Inc.

                   William Tharp        Charles Tharp             Claudia Keith     Estate of Glenda Tharp

Rountree Cotton             16.8%             33.5%                   33.0%                       16.7%
  Co., Inc.


                                Ownership Interests in Other Entities
                                                                                        Estate of
                  William Tharp     Charles Tharp     Claudia Keith      Claud Tharp   Glenda Tharp       Others
                                                                                                           1
Buena Vista           –-                50%               –-                  –-           –-                  50%
  Partnership
Dona Ana Land        14.5%              29                   9%               33%         14.5%                –-
  Corp.
                                                                                                           2
Tharp Family         10.0               10                10                  –-           –-                  70
  Partnership
Tharp Farms          30.0               30                20                  20           --                  --
  Partnership
Tharp Enters.        12.5               25                25                  25           12.5                --
  Partnership
     1
       Craig Tharp, the son of Charles Tharp.
     2
       Each of the following persons owned 10 percent: William “Glenn” Tharp and John Tharp
(the children of William Tharp); Craig Tharp and Laura Kendrick (the children of Charles Tharp);
and Michael Keith, Stanley Keith, and Michelle Gardette (the children of Claudia Keith).