## Facts

- Indmar Products Co., Inc. was a closely held Tennessee corporation manufacturing marine engines; majority ownership was held by Richard Rowe, Sr. and Donna Rowe.
- For years, shareholders advanced funds to Indmar for working capital in exchange for a 10% annual return.
- Beginning in 1993, the advances were memorialized as promissory notes structured as demand loans, with no fixed maturity date or payment schedule, payable upon shareholder demand.
- Indmar recorded the advances as loans on its books, treated payments as interest, and deducted the payments as interest expense on its tax returns.
- Indmar repaid advances when shareholders demanded repayment; on at least one occasion, Indmar borrowed from a bank to satisfy a shareholder’s demand for repayment.
- For tax years 1998–2000, the Commissioner recharacterized the shareholder advances as equity contributions, disallowed Indmar’s claimed interest deductions under I.R.C. § 163(a), and assessed accuracy-related penalties.

## Issues

1. Whether the shareholder advances, documented as demand notes bearing 10% interest and treated by the parties as loans, were bona fide debt or equity contributions for federal tax purposes.
2. Whether Indmar was entitled to deduct payments on the advances as interest under I.R.C. § 163(a).
3. Whether accuracy-related penalties were proper given the characterization of the advances.

## Decision

- The Sixth Circuit reversed the Tax Court.
- The court held the Tax Court clearly erred in finding the advances were equity because it failed to consider relevant debt–equity factors, ignored evidence, and drew unsupported inferences.
- The court found the shareholder advances were bona fide debt and that Indmar could deduct the associated interest payments under I.R.C. § 163(a).
- Because the disallowance of deductions drove the asserted penalties, the debt characterization undermined the penalty determinations tied to the recharacterization.

## Legal Principles

- Debt–equity classification turns on a multi-factor inquiry; no single factor is controlling.
- The governing question is the economic reality of the transaction and whether the parties intended and created a genuine debtor–creditor relationship.
- Demand notes without a fixed maturity date may constitute true debt if they create a legally enforceable repayment obligation and the record shows a reasonable expectation of repayment.
- Objective indicia supporting debt include contemporaneous documentation, a fixed interest rate, consistent treatment in accounting and tax reporting, and actual repayment behavior (including borrowing to meet repayment demands).

## Conclusion

The Sixth Circuit held that shareholder advances documented as demand notes and treated consistently as loans constituted bona fide debt, not equity, so Indmar could deduct the related payments as interest under I.R.C. § 163(a), requiring reversal of the Tax Court’s contrary determination and related penalty outcome.


Indmar Prods. Co. v. Comm’r, 444 F.3d 771 (6th Cir. 2006)