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The Finance Committee report provided the following guidance for determining the interest rate to be used to carry out the purposes of section 483:

The interest rate to be used for purposes of this provision is to be a rate provided by regulations prescribed by the Secretary of the Treasury or his delegate. It is anticipated that any rate specified by the Secretary of the Treasury or his delegate will reflect the going rate of interest and will not be higher than the rate at which a person, in reasonably sound financial circumstances and with adequate security could be expected to borrow money from a bank. (S. Rep. No. 830, 88th Cong., 2d. Sess. 102)

Section 482

B. Present Law

Section 482 provides that—

In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.

This provision has been interpreted as granting broad authority to the Secretary to make adjustments in the income, deductions, credits, or allowances of related business activities to achieve a clear reflection of their respective incomes.

Section 482 has been used to adjust sales prices, charges for services, interest charges, rentals and royalties between related businesses. Use of the provision by the Secretary is discretionary and taxpayers may not rely on section 482 to alter the tax treatment of transactions between related businesses.

The Code establishes three prerequisites to application of section 482. First, there must be two or more organizations, trades or businesses. Second, the entities must be owned or controlled, directly or indirectly, by the same interests. Third, the Secretary must determine that a proposed change is necessary to prevent evasion of taxes or to reflect clearly the income of the entities.

The requirement that there be two or more organizations, trades or businesses generally limits the application of section 482 to transactions in a commercial, as opposed to personal, setting. In defining the term "organization," the Treasury regulations under section 482 refer to an organization as conducting a trade or business. Thus, the concept of "organization" in section 482 is, in part, synonymous with the concept of trade or business. The term "trade or business, as used in the Internal Revenue Code, is not susceptible to a single or simple definition. In Deputy v. DuPont, 308 U.S. 488 (1940), Justice Frankfurter stated that "carrying on any trade or business. . . involves holding one's self out to others as engaged in the selling of goods or services." In a later opinion, the court relied upon the "extent, continuity, variety and regularity" of the taxpayer's activities in finding the existence of a trade or business. Similarly, the mere act of investing is not considered a trade or business, nor is the act of an occasional sale.

Under the definition of trade or business described above, if a parent sold the family farm to a child upon retirement, the transaction would not be subject to section 482 because the parent would not be engaged in a trade or business.

(4)

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The second requirement for application of section 482 is that the requisite trades or businesses be owned or controlled by the same interests. Under existing Treasury regulations, control includes "any kind of control, direct or indirect, whether legally enforceable, and however exercisable or exercised. It is the reality of the control which is decisive not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted." The ability to arbitrarily shift items of income and deduction has become the hallmark of control for purposes of section 482. If the reality of a relationship between two entities includes distinct interests in the organizations and their profits, and an inability of any party to arbitrarily shift the income and deductions of the organizations, then section 482 will not apply. The mere fact that an organization is controlled by a person who is a child, spouse, or sibling of another individual in control of the second organization, does not mean that the organizations are commonly controlled. (Brittingham v. Commissioner, 598 F.2d 1375 (5th Cir. 1979)).

The third requirement for application of section 482 is a determination by the Secretary that application of the section is necessary to prevent tax evasion or to reflect clearly the income of the commonly controlled entities. The regulations define the purpose of section 482 to be the placing of controlled taxpayers on a parity with uncontrolled taxpayers by determining, according to the standard of an uncontrolled taxpayer, the true taxable income from the property and business of a controlled taxpayer. The standard applied in every case is that of an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer. Thus, although the concept of clear reflection of income is not always susceptible to precise definition, for purposes of section 482, tranactions at arm's length will clearly reflect income. For example, if a loan is made by one controlled business to another at a rate above or below the safe harbor rates set forth in the regulations, but at a rate of interest that reflects the prevailing rates charged in similar transactions by unrelated businesses, section 482 will not apply.

Section 483

Section 483 generally provides that if the total deferred payments of the sales price under a contract for the sale or exchange of property includes any unstated interest, a portion of each deferred payment will be treated as interest instead of sales price (sec. 483(a)). In determining whether the total deferred sales price payments include any unstated interest, the total deferred payments of sales price are compared to the sum of the present values of such payments plus the present values of any stated interest payments due under the contract (sec. 483(b)). If the total deferred sales price payments exceed the total present values of sales price and stated interest payments, there is unstated interest.

The present value of a deferred payment is the amount that the parties would agree to pay and receive today instead of waiting for the deferred payment. The determination of this value depends on two factors. The first is the length of time until the deferred payment is to be made. The second factor is the interest rate that represents the value of money over that period. Present values are determined by discounting payments at an interest rate prescribed in regulations

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by the Secretary (sec. 483 (b)). Under existing regulations, the interest rate used to determine whether there is unstated interest is 6 percent simple interest. This rate is referred to as the "test rate."

An example illustrates how the test rate is used to determine whether there is unstated interest. Assume real property is sold under a contract that requires a down payment plus a deferred payment of $100,000 together with $10,000 of stated interest, 2 years after the sale. In determining whether there is unstated interest, the total of deferred sales price payments required under the contract ($100,000) is compared to the present value of such deferred payments plus the present value of stated interest payments (ie., the present value of $110,000 which is $98,215). Because the portion of sales price deferred under the contract ($100,000) exceeds the present value of the deferred payments and stated interest payments under the contract ($98,215), there is unstated interest under the contract.

For purposes of determining how much of a deferred sales price payment is to be treated as interest, a calculation is made similar to the one used to determine whether there is unstated interest. The only difference is that the interest rate used is one percentage point higher than the test rate. This rate is referred to as the "imputed rate" and is 7 percent under existing regulations. As applied to the previous example, the portion of the $100,000 deferred sales price payment that will be treated as interest is the difference between the $100,000 and the sum of present values of the $100,000 payment and the $10,000 interest payment, discounted at 7 percent. The sum of the present values, discounted at 7 percent, is $95,858. Thus, $4,142 of the $100,000 deferred sales price payment will be treated as interest and $95,858 will be treated as sales price. The $10,000 stated interest is not affected by section 483. Thus, the total interest is $14,142 ($10,000+$4,142).

Section 483 generally applies only to those payments made under a contract for the sale or exchange of property that are made more than 6 months after the date of the sale or exchange, if at least one payment is due more than one year after the date of the sale or exchange. Section 483 does not apply to certain deferred payments under contracts for the sale or exchange of property, such as contracts with a sales price that cannot exceed $3,000, certain sales or exchanges of patents, and sales or exchanges that result only in ordinary income to the seller (sec. 483 (f)).

The interest rates used to determine whether there is unstated interest and how much sales price is to be treated as interest must be prescribed in regulations by the Secretary. These interest rates have been adjusted periodically by the Treasury to reflect the prevailing rate of interest in the country.

When the Treasury establishes the test rate and imputed rate to be used under section 483, a single test rate and a single imputed rate are prescribed. Although prevailing interest rates depend on the location of the lender, the kind of property sold, or the credit worthiness of the borrower, the Code contemplates establishment of a single test rate and a single imputed rate. The legislative history indicates that the imputed rate provided under the regulations must reflect the going rate of interest that is not higher than the rate at which a person in reasonably sound financial circumstances and with adequate security

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could be expected to borrow from a bank. Under the statute, the test rate must be at least one percentage point lower than the imputed

rate.

Consequences of applying sections 482 and 483

In general

There are several consequences to the buyer and the seller from treating part of the deferred payments of sales price as interest. Buyer. There are three main consequences for the buyer. First, the buyer has additional interest expenses which will be deductible. Second, the buyer's basis in the property is reduced to reflect the sales price as redetermined under section 482 or 483. Therefore, if the property is depreciable property, the buyer will have smaller allowable depreciation deductions, and if the buyer sells the property the basis for determining gain or loss will not include the imputed interest element. Finally, if the buyer is eligible for an investment tax credit, the qualified investment in the property (the amount used in determining the amount of the credit) is reduced to exclude the interest element. Under present law, the buyer will usually experience a net tax savings from an increase in the amount of a payment treated as interest.

Seller: The effect on the seller is to reduce the gain (or increase the loss) on the sale or exchange and increase the amount of interest income. The net effect is to reduce the amount of capital gain recognized and recharacterize it as ordinary income. Since long-term capital gains are normally taxed at a lower rate than ordinary income, the seller would usually experience an increase in its tax liability.

Section 483 does not increase the total amount of sales price and interest payments made under a contract. Instead, part of the sales price is recharacterized as interest under the imputed rate, with the tax effects mentioned above.

Related party and intra-family transactions

In the case of a transaction between related taxpayers, sales prices below fair market value may raise other tax issues. For example, in a transaction between a corporation and one of its shareholders, the difference between the selling price and the property's fair market value could be considered a dividend or a capital contribution.

In a transaction between family members, a sale at less than fair market value or an interest-free purchase money mortage raises the issue of whether a gift has been made. In this regard, a taxpayer could argue that application of section 483 to the gift portion of a transfer is precluded by the statutory reference limiting section 483 to sales or exchanges of property.'

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In For v. United States, 33 AFTR 2d 74-1118 (E.D. Pa. 1974), aff'd, 510 F.2d 1330 (3d Cir. 1975), the court held that section 483 was intended to apply in commercial settings and not to marital property settlements. On appeal, the Third Circuit affirmed the lower court decision by reasoning that section 483 which is general in its application did not override specific provisions of sections 71 and 215. The Internal Revenue Service has agreed with the Third Circuit's holding (Rev. Rul. 76-146, 1976-1 C.B. 144).