Information on Cash Advance Loan

* Milenbach. CA-9. February 6. 2003

Disputes from 20 years ago when the Raiders football team left Oakland, California for Los Angeles reached the Ninth Circuit Court of Appeals recently. Although the court overturned the Tax Court's decision, the taxpayer's victory was only partial. It successfully persuaded the appellate court that loan proceeds were not advance income but failed to convince the court that settlement proceeds were nontaxable return of capital.

Background

In 1980, the taxpayer announced it was moving to Los Angeles and executed a number of contracts with the Los Angeles Memorial Coliseum, which agreed to lend the taxpayer $7 million. The taxpayer promised to repay the loan from 12 percent of the net receipts from luxury suites at the coliseum.

At the time of the contract, the luxury suites were not yet constructed. The taxpayer agreed to begin construction as soon as possible. Ultimately, the suites were never built and the taxpayer never repaid the loan.

* Comment. The taxpayer received $4 million up front in cash and $3 million in credits against future rent.

The IRS disallowed the taxpayer's rent deductions because the rent was part of the loan. The IRS also determined that the $4 million initial payment and the rent credits were advance payments of income. The Tax Court agreed.

* Comment The Tax Court found that the contract between the taxpayer and the coliseum was illusory. There was never a legally enforceable obligation for repayment.

Enforceable contract

The Ninth Circuit rejected the Tax Court's finding that the contract was illusory. Although the contract did not require the suites to be built by a specific date, the taxpayer was obligated to use its best efforts to construct the suites as soon as possible. The taxpayer also agreed to operate the suites for maximum profit. It did neither but the contract imposed on the taxpayer a legally enforceable obligation to repay the loan. Consequently, the $4 million initial payment and the rent credits were excludable from income.

Lost profits

When the taxpayer announced its intention to relocate to Los Angeles, Oakland filed an eminent domain action to condemn for public use the taxpayer's franchise and assets. Oakland's action failed and the taxpayer sought damages. Oakland and the taxpayer settled their dispute for $4 million.

The Tax Court found that the settlement was compensation for lost profits, which are taxable.

On this question, the Ninth Circuit agreed with the Tax Court. The appellate court rejected the taxpayer's argument that the language of the settlement, which characterized the agreement as restoration of lost franchise value, should control. The court reminded the taxpayer that it is not bound by any allocation made by parties to a settlement if evidence exists that payments represent something else.

Forfeiture

Because of the taxpayer's dispute with Los Angeles over the suites and other issues, the taxpayer explored construction of a new stadium in Irwindale, California. Irwindale agreed to lend the taxpayer $115 million to build a stadium. Repayment would come from stadium revenue.

* Comment. Irwindale advanced the taxpayer $10 million in cash.

Unfortunately for Irwindale, the state legislature barred it from issuing bonds to fund construction of the stadium. The stadium was never built.

The IRS determined that the $10 million advance was taxable income. The Tax Court disagreed and found that the advance was a loan. However, the taxpayer was not obligated to repay it.

The contract excused the taxpayer from repaying the advance if Irwindale failed to perform its obligations. When the state legislature took away Irwindale's bond authority, Irwindale could not satisfy its contractual obligations and it forfeited the $10 million advance.

The Ninth Circuit disagreed. It found that the date of forfeiture was unclear. It acknowledged that Irwindale's ability to fullfill its contractual obligations was impaired when the state intervened, but it found that the parties had explored alternative financing afterwards. The appellate court instructed the Tax Court to determine precisely when forfeiture occurred.

References: 2003-1 USTC P50,229; FTS (sec)E.-8.40.