In Uncategorized on 09/07/2017 at 19:34

When you’re trying to write off a bum investment as a business bad debt, that is. William J. Rutter, 2017 T. C. Memo. 174, filed 9/7/17 (that’s Dr. Wm. J. Rutter to you) has an impressive resume and was a major player in the biotech field. But one of his biotech start-ups soured in the 2008 meltdown, and when Google walked away from negotiating a deal, Dr. Wm. looked to bail.

Dr. Wm.’s C Corp, which Judge Lauber abbreviates as IM (and I’ll follow suit), had a strange capital structure. There were 70 common shareholders, but they were hardly a hair on the tail of the IM dog. Dr. Wm. Kept IM alive with capital contributions, at first papered with convertible promissory notes, which he converted before the year at issue, and thereafter with unpapered cash infusions.

He claimed all this was debt, and wrote it down on a FIFO theory, claiming it was all bad in year at issue, even though he was still hondling, if I may use an arcane technical term, with Google to buy his brilliant ideas.

Well, Dr. Wm. crashes 10 out of 11 fences in the Ninth Cir. debt-vs-equity dressage, and he gets by the one only by a squeaker. It’s our old chum economic substance. No lender would lend to IM as Dr. Wm. did, he had no paperwork (what he did have was done up after the fact and backdated), and his only source of repayment was a sale of IM, like a hedgefundamentalist, not a lender.

Judge Lauber: “Petitioner testified that he hoped to secure ultimate repayment upon sale of IM to a third party or a third-party investment in IM.  But this is the hope entertained by the most speculative types of equity investors, such as venture capitalists and private equity firms.  Petitioner was a ‘classic capital investor hoping to make a profit, not * * * a creditor expecting to be repaid regardless of the company’s success or failure.’ The fact that a corporate buyout was petitioner’s ultimate expected source of repayment strongly supports characterization of his advances as equity.” 2017 T. C. Memo. 174, at p. 21 (citation omitted).

It goes downhill from there. Dr. Wm.’s expert evaluates the worth of IM at year-end (year at issue), but is undone by IRS’ expert who notes that IM was smashed-and-sinking to begin with.

And Dr. Wm. wasn’t in the moneylending business. He only worked with his own start-ups. Just spending a lot of time working on a corporation’s affairs doesn’t put you in a business. And Dr. Wm. wasn’t a professional promoter, an in-and-out trader in new businesses. He rode with IM for years, putting in cash as needed.

And he kept advancing money to IM even after the year at issue. If his past debt was worthless, why throw good money after bad?

Of course the 20% chop follows. Dr. Wm.’s back-office dude, who worked with the CPA who prepared the return for Dr. Wm., never bothered to tell the CPA that there were no promissory notes and that no interest had ever been paid, blowing away three of the Ninth Cir. eleven criteria. No good faith reliance.



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