Karns Prime & Fancy Food, Ltd. v. Comm’r of Internal Revenue, No. 06-1031, UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT (Filed: July 20, 2007)

A grocery store chain, Karns, borrowed $1.5 million from its principal supplier, Super Rite. The IRS claimed that the $1.5 million was taxable income. Karns argued that the money was a loan. (By law, loans are not taxable).

For the Third Circuit court, the key question was whether, at the time Karns received the money, was it unconditionally obligated to repay the loan. Super Rite provided Karns with $1.5 million on condition that it purchases $16 million of Super Rite’s products a year. As long as Karns fulfilled its terms of the bargain, i.e., to purchase $16 million of Super Rite’s product, the $1.5 million “was its to keep.” Therefore, yesterday, the court ruled that the $1.5 million was NOT a loan.

Karns has to pay $486,355 in taxes on its $1.5 million income. 

Business Law Lesson: Do not attempt to avoid taxes by classifying received money as a loan instead of income. Borrowing money from your principals or suppliers with no real obligation to repay the money is not a “loan” for tax purposes.

Sharmil McKee | Business Lawyer | blog@mckeeoffice.com