                          T.C. Memo. 2005-233



                       UNITED STATES TAX COURT



          KARNS PRIME & FANCY FOOD, LTD., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 906-04.                 Filed October 5, 2005.



     John D. Sheridan and Steven J. Schiffman, for petitioner.

     Gerald A. Thorpe, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined a deficiency of

$486,355 in petitioner’s Federal income tax (tax) for the taxable

year ended January 30, 2000 (year at issue).

     The only issue for decision is whether the $1.5 million

($1.5 million at issue) that petitioner received from its princi-

pal supplier during the year at issue constitutes a loan that is
                                - 2 -

not includable in its gross income.     We hold that it does not.

                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

     At the time of the filing of the petition in this case,

petitioner’s principal place of business was in Mechanicsburg,

Pennsylvania.

     During the year at issue, petitioner, a corporation orga-

nized under the laws of Pennsylvania, operated several grocery

stores in towns located around Harrisburg, Pennsylvania.     During

that year, Super Rite Foods, Inc. (Super Rite), one of peti-

tioner’s suppliers of grocery items since the 1970s, was peti-

tioner’s principal supplier.

     In 1998, Scott Karns (Mr. Karns), who at all relevant times

was petitioner’s chief executive officer, concluded that peti-

tioner needed $1.5 million for capital improvements.     In that

year, Mr. Karns approached Dale Conklin (Mr. Conklin), who was

then president of Super Rite, to discuss obtaining financial

assistance from Super Rite for petitioner’s capital needs.

     At certain times during the relevant time period, certain of

Super Rite’s customers approached it seeking some form of finan-

cial assistance (e.g., an advance of funds, a lease guaranty, a

supply agreement commitment).   Although Super Rite preferred that

its customers obtain financial assistance from outside sources,

from time to time (around 10 to 15 times a year) it decided to
                              - 3 -

provide some form of financial assistance to certain of its

creditworthy and strategically important customers in order to

help them meet their respective financial needs.   The amount of

funds that Super Rite was willing to advance to a customer

depended upon Super Rite’s estimate of its potential profit under

the supply agreement that it required of such customer.

     Before Super Rite agreed to provide financial assistance to

a customer, it required each such customer to (1) enter into a

written supply agreement (supply agreement) that, inter alia,

required the customer to purchase annually a minimum amount of

products and that contemplated that Super Rite would pay an

advance price rebate to such customer at the inception of such

supply agreement and (2) execute a promissory note (note) payable

to Super Rite in the amount of any such advance rebate.   Although

Super Rite expected that the customer would satisfy the minimum

annual purchase requirement set forth in the supply agreement,

Super Rite nonetheless required the customer to execute a note

payable to it in order to facilitate repayment of all or a

portion of such advanced funds in the event that the customer did

not satisfy such minimum annual purchase requirement or otherwise

materially breached the supply agreement.1   Super Rite intended


     1
      Even in a situation where a customer of Super Rite did not
seek an advance of funds from Super Rite, Super Rite may have
agreed to enter into a supply agreement with such customer that,
inter alia, required the customer to purchase annually a minimum
                                                   (continued...)
                               - 4 -

that the customer’s obligation to repay funds that it advanced

would arise only if the customer materially breached the supply

agreement.

     While petitioner was negotiating with Super Rite with

respect to the terms of the supply agreement and the correspond-

ing note that Super Rite required as conditions to Super Rite’s

advancing any funds to it, petitioner requested, and received,

permission from PNC Bank, petitioner’s primary bank, to enter

into such supply agreement and to execute such note.   That is

because petitioner had outstanding indebtedness to PNC Bank, and

the loan documents with respect to that indebtedness required PNC

Bank’s permission before petitioner entered into any transaction

in which it received an advance of funds that it might have to

repay and/or with respect to which certain of petitioner’s assets

were to serve as collateral.   In all events, PNC Bank was to

retain a first security interest in any assets of petitioner that

served as collateral with respect to petitioner’s outstanding




     1
      (...continued)
amount of products and that contemplated that Super Rite would
pay an advance price rebate to such customer at the inception of
such supply agreement. Before Super Rite entered into such a
supply agreement, it required the customer to execute a note
payable to Super Rite in the amount of any such advance rebate in
order to facilitate repayment of such advanced funds in the event
that the customer did not satisfy the minimum annual purchase
requirement set forth in the supply agreement or otherwise
materially breached that agreement.
                                 - 5 -

indebtedness to that bank.2

         As a result of negotiations between Mr. Conklin and Mr.

Karns, Super Rite agreed to advance $1.5 million to petitioner

and petitioner agreed to execute the supply agreement and the

corresponding note required by Super Rite.3    In agreeing to the

$1.5 million advance to petitioner and to the terms of the supply

agreement and the corresponding note that Super Rite required of

petitioner, Super Rite had concluded, inter alia, that petitioner

would be entitled to an estimated $1.5 million rebate under such

supply agreement if petitioner did not materially breach that

agreement.4

     On April 16, 1999, petitioner executed the supply agreement

(April 16, 1999 supply agreement) that Super Rite required of

petitioner as a condition to Super Rite’s advancing $1.5 million

to it.     Petitioner also executed the corresponding $1.5 million




     2
      The supply agreement between petitioner and Super Rite
(discussed below) provided that PNC Bank was to have a first
security interest in certain equipment that was described in that
agreement as collateral with respect to petitioner’s obligations
under the supply agreement.
     3
      Prior to agreeing to enter into a supply agreement with
Super Rite, petitioner did not have a supply agreement with that
supplier.
     4
      Prior to agreeing to enter into a supply agreement with
Super Rite, petitioner did not receive any price rebates from
Super Rite with respect to its purchase of products from that
supplier.
                              - 6 -

note (April 15, 1999 note)5 dated April 15, 1999, and payable to

Super Rite that Super Rite also required of petitioner as a

condition to Super Rite’s advancing $1.5 million to it.

     Pursuant to the April 16, 1999 supply agreement, petitioner

agreed to purchase annually from Super Rite $16 million in

products over a six-year period.   The April 16, 1999 supply

agreement provided in pertinent part:

          1.   Supply of Requirements; Certification.
     Throughout the term of this Agreement, Super Rite will
     be the principal wholesaler for all products purchased
     by the Retailer [petitioner] for sale in the Retailer’s
     stores that are located within the geographic area
     served by Super Rite. Throughout the term of this
     Agreement, the Retailer shall purchase at least
     $16,000,000.00 of product from Super Rite each year of
     this Agreement. * * *

          2.   Pricing and Payment Terms. During the term
     of this Agreement, product pricing, fees, billing and
     payment terms, returns and credits for products pur-
     chased, and other terms and conditions governing the
     sale of products hereunder shall be governed by Super
     Rite’s general policies and practices in effect from
     time to time. In addition, Retailer shall receive a
     private label incentive to be determined on the basis
     of Exhibit A attached hereto and further, Retailer fees
     for Grocery, Frozen and Dairy shall be in accordance
     with Exhibit B attached hereto.[6] The parties further
     agree that Retailer’s payment terms shall be seven (7)
     days. Failure by the Retailer to make payment to Super
     Rite of amounts due for the delivery of goods hereunder


     5
      By using the term “April 15, 1999 note”, we do not intend
to suggest that for tax purposes there was a loan by Super Rite
to petitioner that was evidenced by that document.
     6
      Prior to the April 16, 1999 supply agreement, Super Rite
(1) did not provide petitioner with any incentives for private
label purchases and (2) charged petitioner fees higher than those
set forth in exhibit B attached to that supply agreement.
                         - 7 -

in accordance with the payment terms governing any
shipment of goods shall constitute a default hereunder
and, in addition to its rights under Section 5 of this
Agreement, Super Rite may suspend shipments to the
Retailer for so long as such default remains uncured.

     3.   Term. This Agreement shall remain in full
force and effect until April 16, 2005. Thereafter,
this Agreement shall automatically be renewed for
successive periods of one (1) year each unless either
party gives written notice to the other party at least
sixty (60) days prior to the expiration of the initial
term or any renewal term hereof that it desires to
terminate this Agreement at the end of such term.

     4.   Delays in Supply. Neither party hereto shall
be liable for any default or delay in the performance
of its obligations hereunder caused by any contingency
beyond its control * * *. In the event of a Delay that
materially impairs Super Rite’s shipments to the Re-
tailer or the Retailer’s purchases from Super Rite, the
other party’s obligations hereunder shall be reduced
for the period including the Delay in proportion to the
impairment and, in the case of a Delay affecting Super
Rite, the Retailer shall be expressly permitted to
cover such reductions by purchases from other wholesal-
ers (it being expressly understood that Super Rite
shall incur no liability to the Retailer for any in-
creased costs or expenses related thereto). * * *

     5.   Cancellation by Super Rite. Super Rite may
cancel this Agreement: (i) upon the failure by the
Retailer to make payment to Super Rite in accordance
with Section 2 hereof for goods delivered hereunder;
(ii) immediately upon the filing of a petition for
relief by the Retailer in a voluntary proceeding under
applicable federal or state bankruptcy law or like laws
for the protection of debtors or upon the application
of the Retailer to any court or administrative agency
of competent jurisdiction for the appointment of a
receiver or trustee for the administration of the
Retailer’s affairs; (iii) upon the filing of a petition
for relief with respect to the Retailer in an involun-
tary proceeding under applicable federal or state
bankruptcy law or like laws for the protection of
debtors or upon the application by a third party to any
court or administrative agency of competent jurisdic-
tion for the appointment of a receiver or trustee for
                         - 8 -

the administration of the affairs of the Retailer, if
an order for relief shall be entered and continued
unstayed in effect for thirty (30) days or such peti-
tion or application shall continue undismissed for
sixty (60) days; (iv) following the breach of any
obligation of the Retailer hereunder, if such breach is
not cured within thirty (30) days following notice
thereof to the breaching party; (v) following the
default by Retailer in the performance of or compliance
with any material contract, instrument or agreement,
including, without limitation, any lease of real prop-
erty, any material lease of personal property or any
promissory note, instrument or agreement evidencing or
in respect of any indebtedness for borrowed money or
any security therefor, if such default is not cured
within any applicable period of grace, or (vi) immedi-
ately upon the occurrence of a material adverse change
in the condition (financial or otherwise), business or
prospects of the Retailer or any guarantor of the
Retailer’s liabilities and obligations hereunder. * * *

     6.   Cancellation by the Retailer. The Retailer
may cancel this Agreement: (i) immediately upon the
filing of a petition for relief by Super Rite in a
voluntary proceeding under applicable federal or state
bankruptcy law or like laws for the protection of
debtors or upon the application of Super Rite to any
court or administrative agency of competent jurisdic-
tion for the appointment of a receiver or trustee for
the administration of Super Rite’s affairs; (ii) upon
the filing of a petition for relief with respect to
Super Rite in an involuntary proceeding under applica-
ble federal or state bankruptcy law or like laws for
the protection of debtors or upon the application by a
third party or [sic] any court or administrative agency
of competent jurisdiction for the appointment of a
receiver or trustee for the administration of the
affairs of Super Rite, if an order for relief shall be
entered and continued unstayed in effect for thirty
(30) days or such petition or application shall con-
tinue undismissed for sixty (60) days; or (iii) follow-
ing the breach of any obligation of Super Rite hereun-
der, if such breach is not cured within thirty (30)
days following notice thereof to Super Rite. * * *
                         - 9 -

     7.   Liquidated Damages. The parties understand
that Super Rite’s commitment to supply the specified
requirements of the Retailer will require an allocation
of resources by Super Rite that would not be practical
if the Retailer were to purchase less than such speci-
fied percentage requirements from Super Rite. The
parties agree that the Retailer’s failure to perform
its obligations hereunder will cause damage to Super
Rite that will be difficult or impossible to prove
accurately and, therefore, with the intention of pro-
viding a fair and reasonable formula to calculate the
amount of such damage, the parties agree that upon
Super Rite’s cancellation of this Agreement pursuant to
Sections 2 or 5 of this Agreement, the Retailer will
pay Super Rite as liquidated damages an amount equal to
1.0% of the product of (i) the Retailer’s aggregate
purchases from Super Rite during the preceding calendar
year multiplied by (ii) the number of years remaining
in the term of this Agreement. The amount of the
Retailer’s aggregate purchases and Super Rite’s damages
for periods of less than one year shall be calculated
on a pro rata basis.

     8.   Pledge on Assets. As collateral security for the
prompt and complete payment and performance when due of
all of Retailer’s liabilities and obligations to Super
Rite hereunder, Retailer hereby mortgages, pledges,
hypothecates and grants to Super Rite a lien and secu-
rity interest in all right, title and interest which
Retailer may now or hereafter have in, to and under the
following, wherever located (collectively, the “Collat-
eral”): (i) all “Inventory”, as such term is defined
in Section 9-106(4) of the Uniform Commercial Code
* * * (the “Code”) * * *; (ii) all “Accounts” as such
term is defined in Section 9-106 of the Code * * *;
(iii) all “Equipment” as such term is defined in Sec-
tion 9-109(2) of the Code * * *; and (iv) all “Pro-
ceeds” of the foregoing, as such term is defined in
Section 9-306(1) the Code [sic] * * *. Retailer cove-
nants that during the term of this Agreement it will
not, without Super Rite’s prior written consent, cre-
ate, incur, assume, or suffer to come into existence
any mortgage, pledge, lien or other encumbrance upon
any of the Collateral or the Proceeds thereof, wherever
located, now existing or hereafter acquired, other than
that granted to Super Rite hereunder. Retailer agrees
to execute and deliver such documents, and to take such
action, as Super Rite may request to perfect and con-
                             - 10 -

     tinue Super Rite’s lien on and security interest in
     such Collateral. Provided, however, Super Rite ac-
     knowledges that PNC Bank has first place security
     interest on Retailer’s equipment located at its’ [sic]
     West Shore Plaza Store.

          8.1.    Financial Statements. Retailer shall
     furnish to Super Rite, no later than ninety (90) days
     after the end of each fiscal quarter of Retailer, the
     internal statements of Retailer and every six months
     the reviewed balance sheet of Retailer, together with
     its statement of income, retained earnings and cash
     flow for the fiscal quarter. Each year, upon
     Retailer’s request, Super Rite shall provide Retailer
     with a letter confirming the forgiveness of debt in
     accordance with that Promissory Note, of even date
     herewith,[7] by and between Super Rite and Retailer.

          9.   Coupon Redemption Service. During the term
     of this Agreement, Retailer agrees to use Super Rite’s
     coupon service for the redemption of all coupons re-
     ceived by Retailer [and] to pay for such service at the
     rates established by Super Rite from time to time.[8]

     The April 15, 1999 note provided in pertinent part:

          FOR VALUE RECEIVED, KARNS PRIME & FANCY FOODS,
     LTD., * * * (the “Borrower”), hereby promises to pay to
     the order of SUPER RITE FOODS, INC., * * * (the
     “Lender”), * * * the principal sum of ONE MILLION FIVE
     HUNDRED THOUSAND NO/100 DOLLARS ($1,500,000.00). The
     Borrower hereby further promises to pay interest on the
     unpaid principal balance hereof at a rate per annum
     equal to the Prime Rate (as hereinafter defined) plus
     1% * * *. Interest shall accrue daily from the date


     7
      The April 16, 1999 supply agreement referred to the April
15, 1999 note as a note of “even date”. The record does not
clarify the inconsistency between the date of that note to which
the supply agreement referred (i.e., Apr. 16, 1999) and the date
of that note to which such note referred (i.e., Apr. 15, 1999).
What is clear from the record is that the April 16, 1999 supply
agreement and the April 15, 1999 note were entered into around
the same time and were interdependent. See infra note 9.
     8
      Prior to the April 16, 1999 supply agreement, petitioner
was not entitled to Super Rite’s coupon redemption service.
                              - 11 -

     hereof on the unpaid principal balance hereof and shall
     be computed on the basis of the actual number of days
     for which due.

          The principal balance of this Note shall be repaid
     in six (6) annual payments of $250,000.00 each, com-
     mencing on April 16, 2000, and continuing on the third
     Friday of each April thereafter through and including
     April 16, 2005; provided however, that the payment of
     the annual payment shall be forgiven by the Lender
     [Super Rite] if the Lender determines that the Borrower
     is in compliance with, and shall not have materially
     breached or then be in uncured default under, that
     certain Supply and Requirements Agreement of even date
     herewith[9] among the Borrower and Lender. The entire
     unpaid and unforgiven principal balance hereof shall be
     due and payable, if prior to April 16, 2005, Borrower
     ceases, for any reason, to use Lender as its primary
     food supplier. Notwithstanding the foregoing, the
     entire unpaid and unforgiven principal balance hereof
     and accrued interest thereon shall be due and payable
     on April 16, 2005.

     Even though execution of the April 16, 1999 supply agreement

and the corresponding April 15, 1999 note occurred in mid-April

1999, it was not until around May 4, 1999, that petitioner

received the $1.5 million at issue.10   Around that last date,

Rich Foods, Inc. (Rich Foods), the then parent of Super Rite,


     9
      The April 15, 1999 note referred to the April 16, 1999
supply agreement as a supply agreement of “even date”. The
record does not clarify the inconsistency between the date of
that supply agreement to which the note referred (i.e., Apr. 15,
1999) and the date of that supply agreement to which such supply
agreement referred (i.e., Apr. 16, 1999). What is clear from the
record is that the April 15, 1999 note and the April 16, 1999
supply agreement were entered into around the same time and were
interdependent. See supra note 7.
     10
      The record does not explain why petitioner did not receive
until May 4, 1999, the $1.5 million to which the April 16, 1999
supply agreement and the corresponding April 15, 1999 note
pertained.
                               - 12 -

gave petitioner a $1.5 million check drawn on Rich Foods’ check-

ing account.

     During the year at issue in August 1999, SUPERVALU, Inc.

(SUPERVALU), acquired Rich Foods.    SUPERVALU recorded the $1.5

million advanced to petitioner in SUPERVALU’s fixed asset ledger

as a supply rebate that was to be amortized over six years in

monthly installments of $19,230.77.     Petitioner recorded the

April 15, 1999 note in its books and records as a long-term note

payable.

     Petitioner expended $750,000 of the $1.5 million at issue on

capital improvements and temporarily invested the balance in

certificates of deposit (CDs).    Petitioner pledged the CDs as

collateral for a $960,000 loan from PNC Bank.     Petitioner used

the $960,000 in PNC Bank loan proceeds for capital improvements.

     During the latter part of the year at issue, Mr. Karns

concluded that it would be desirable to relocate one of peti-

tioner’s stores.   As a result, he entered into negotiations to

lease a new site for that store.    The prospective lessor of that

site refused to lease it to petitioner without a guaranty of

petitioner’s lease obligations.

     At all relevant times, SUPERVALU agreed to act from time to

time as a guarantor of a customer’s lease obligations where

SUPERVALU concluded that to do so would serve SUPERVALU’s busi-

ness interests.    Around January 25, 2000, SUPERVALU guaranteed
                              - 13 -

petitioner’s obligations under the lease (petitioner’s lease) of

the new site for one of petitioner’s stores.   In return for

SUPERVALU’s guaranty of petitioner’s lease, on January 26, 2000,

petitioner entered into several agreements with SUPERVALU,

including:   (1) An agreement that granted to SUPERVALU a security

interest in certain of petitioner’s assets;11 (2) a first amend-

ment to the April 16, 1999 supply agreement that, inter alia,

amended the term of that supply agreement12 but that did not

alter petitioner’s annual purchase requirement under the April

16, 1999 supply agreement; (3) a retailer’s agreement that

(a) required SUPERVALU to make its product lines available to

petitioner at certain prices and to provide petitioner with

certain services, including field advisory, warehousing, and

marketing services, and (b) required petitioner to comply with

SUPERVALU’s payment, accounting, inventory, and confidentiality



     11
      Around early February 2000, SUPERVALU filed financing
statements with Cumberland County, Pa., and the Pennsylvania
secretary of state in order to perfect the security interest in
certain of petitioner’s assets that petitioner granted to
SUPERVALU on Jan. 26, 2000.
     12
      The first amendment to the April 16, 1999 supply agreement
provided in pertinent part:

     The term of the [April 16, 1999 supply] Agreement is
     hereby amended such that Retailer’s [petitioner’s]
     obligations under this Agreement shall continue in
     effect for the longer of (a) five (5) years from the
     Execution Date, or (b) as long as any Capital Commit-
     ment [i.e., any capital committed by SUPERVALU for the
     benefit of petitioner] remains outstanding.
                              - 14 -

requirements; (4) a mediation/arbitration agreement that required

petitioner and SUPERVALU to resolve any controversy, claim, or

dispute by mediation or arbitration; and (5) a reimbursement

agreement that required petitioner to pay annually to SUPERVALU

10 percent of the petitioner’s lease value.   In addition, as was

customary for SUPERVALU when it guaranteed one of its customer’s

lease obligations, SUPERVALU required petitioner to enter into an

option agreement with SUPERVALU that gave SUPERVALU the right to

take over petitioner’s lease in the event that petitioner de-

faulted under it.13

     On January 26, 2000, petitioner’s officers, who were also

stockholders of petitioner, executed an agreement in which they

guaranteed various obligations that petitioner had to SUPERVALU

and/or its subsidiaries.   Such obligations included petitioner’s

obligations under the April 16, 1999 supply agreement and the

corresponding April 15, 1999 note.

     Petitioner satisfied the annual purchase requirement set

forth in the April 16, 1999 supply agreement for each of the

periods ended April 16, 2000, and April 16, 2001, and otherwise

complied with, did not materially breach, and was not in uncured




     13
      It has been SUPERVALU’s practice to take over customer
leases that it guaranteed where its customers were in default
under them.
                              - 15 -

default under that supply agreement.14    As a result, petitioner

was not obligated to make on each of those dates the annual

payment set forth in the April 15, 1999 note.    In petitioner’s

books and records for each of the years ended January 30, 2001,

and January 30, 2002, petitioner reduced by $250,000 the balance

of its long-term notes payable.   In each of petitioner’s tax

returns for those respective years, petitioner reported $250,000

as “Other Income--Reduction of Supplier Note Agreement”.

     On March 9, 2001, petitioner executed a document entitled

“COMMERCIAL NOTE” (March 9, 2001 commercial note)15 payable to

SUPERVALU in the amount of $300,000.     On or about the same date,

petitioner received a $300,000 check drawn on an account of

SUPERVALU.   The March 9, 2001 commercial note provided in perti-

nent part:

          FOR VALUE RECEIVED, Karns Prime and Fancy Food
     Ltd. * * * (collectively the “Maker”), promise[s] to
     pay to SUPERVALU * * * (“Lender”) * * * the principal
     sum of Three Hundred Thousand and No/100 Dollars
     ($300,000.00), plus interest, all as set forth below.


     14
      Instead of discussing whether petitioner complied with,
materially breached, and/or was in uncured default under the
April 16, 1999 supply agreement, for convenience, we shall
discuss only whether petitioner was in material breach of or
materially breached that supply agreement. However, our refer-
ences to whether petitioner was in material breach of or materi-
ally breached the April 16, 1999 supply agreement are intended
also to pertain to whether petitioner complied with and/or was in
uncured default under that supply agreement.
     15
      By using the term “March 9, 2001 commercial note”, we do
not intend to suggest that for tax purposes there was a loan by
SUPERVALU to petitioner that was evidenced by that document.
                          - 16 -

     Interest upon all principal advanced under this
Note shall accrue, from the date of its advance and
until repaid, at a rate of ten and seven tenths percent
(10.70%) per annum. * * *

Principal and interest due Lender under this Note shall
be payable as follows:

(a)    A payment of Ninety One Thousand Five Hundred Two
       and 83/100 Dollars ($91,502.83), including princi-
       pal and accrued and unpaid interest, shall be due
       and payable on March 9 2002; a payment of Ninety
       One Thousand Five Hundred Two and 83/100
       Dollars($91,502.83), including principal and ac-
       crued and unpaid interest, shall be due and pay-
       able on March 9 2003; a payment of Ninety One
       Thousand Five Hundred Two and 83/100
       Dollars($91,502.83), including principal and ac-
       crued and unpaid interest, shall be due and pay-
       able on March 9 2004, a payment of Ninety One
       Thousand Five Hundred Two and 83/100
       Dollars($91,502.83), including principal and ac-
       crued and unpaid interest, shall be due and pay-
       able on March 9 2005; and

(b)    The entire remaining principal balance, plus all
       accrued and unpaid interest, shall be due and
       payable in full on June 9, 2005.

   *        *       *       *       *        *       *

     This Note shall be IN DEFAULT and, at Lender’s
option, the total unpaid principal under this Note, all
accrued interest thereon and all other amounts owed by
any Maker to Lender, whether evidenced by this Note or
otherwise, shall be immediately due and payable, with-
out notice, protest, or demand, upon the occurrence of
any one or more of the following events of default:
(a) the failure of any Maker to pay any amount when due
or to perform any other obligation as required under
this Note; (b) the occurrence of any default by any
Maker or any future guarantor (there presently being no
guarantors) of this Note (called a “Guarantor” below)
under any other obligation to or agreement with Lender
or any SUPERVALU Entity (as defined below), including
any default by any Maker or any Guarantor under any
supply agreement in favor of any SUPERVALU Entity and
any failure by any Maker or any Guarantor to pay any
                              - 17 -

     open account obligation to any SUPERVALU Entity; * * *

          If this Note, any payment required to be made
     under this Note or any other obligation payable to
     Lender or any SUPERVALU Entity is not paid on the due
     date (whether at original maturity or following accel-
     eration), in addition to any other rights Lender may
     have under this Note, any related agreement or under
     applicable law, Lender shall have the right to set off
     the indebtedness evidenced by this Note against any
     indebtedness of Lender or any SUPERVALU Entity to any
     Maker or Guarantor. [Reproduced literally.]

     On March 9, 2001, petitioner and SUPERVALU also entered into

a second amendment to the April 16, 1999 supply agreement (March

9, 2001 supply agreement second amendment).   The March 9, 2001

supply agreement second amendment provided in pertinent part:

     1.   Purchase Requirement

          Effective as of the Execution Date and continuing
          throughout the term of the [April 16, 1999 supply]
          Agreement, Retailer [petitioner] shall purchase at
          least $21,000,000 of product from Wholesaler
          [Super Rite] each year of the Agreement.

     2.   Sales Rebate

          As additional consideration for Retailer’s enter-
          ing into this Agreement, and provided no Retailer
          Entity is in default under this Agreement or under
          any Capital Commitment or other agreement with, or
          obligation to, any SUPERVALU Entity, Wholesaler
          shall rebate to Retailer a rebate (the “Rebate”),
          on the terms and conditions set forth below:

          2.1   The purchases on which the Rebate shall be
                based (the “Aggregate Purchases”) shall be
                the total purchases of Product from Whole-
                saler by Retailer for all of the Supermarkets
                in the Aggregate, up to a maximum total of
                Aggregate Purchases over the term of this
                Agreement of $89,250,000.

          2.2   The Rebate shall be calculated annually,
                               - 18 -

               based on the Aggregate Purchases for the
               twelve month period immediately preceding an
               anniversary of the Execution Date (the “An-
               nual Period”).

         2.3   The Aggregate Purchases for the Annual Period
               shall be multiplied by four thousand three
               hundred sixty seven ten-thousandths percent
               (.4367%), and the product of such calculation
               shall be the amount of the Rebate payable by
               Wholesaler to Retailer for such Annual Pe-
               riod.

         2.4   The amount of the Rebate shall be shown as a
               credit on the first statement sent by Whole-
               saler to Retailer following the end of the
               Annual Period.

         Notwithstanding anything to the contrary which may
         be contained in this Section 5, at such point, if
         any, that the Aggregate Purchases reach
         $89,250,000, no further purchases shall be consid-
         ered Aggregate Purchases, and no Rebate shall be
         due or payable with respect to any purchases which
         are not considered Aggregate Purchases. Whole-
         saler may offset against any Rebate any amounts
         owed to any SUPERVALU Entity by any Retailer En-
         tity, and Wholesaler shall discontinue paying the
         Rebate altogether upon any default by any Retailer
         Entity under this Agreement, under any Capital
         Commitment, or under any other agreement with, or
         obligation to, any SUPERVALU Entity. Wholesaler
         shall have no obligation whatsoever to pay any
         Rebate in the event any Retailer Entity commences
         any proceeding under any bankruptcy, reorganiza-
         tion or similar law, or in the event a similar
         proceeding is filed against any Retailer Entity.

     *         *       *         *      *      *       *

4.       Agreement Continues

         Except as specifically amended herein, the Agree-
         ment continues, unmodified, in full force and
         effect.

For the annual period ended March 9, 2002, petitioner met
                               - 19 -

the increase in petitioner’s annual purchase requirement under

the March 9, 2001 supply agreement second amendment, i.e., an

increase of $5 million in required annual product purchases over

the $16 million in required annual product purchases set forth in

the April 16, 1999 supply agreement before its amendment by the

March 9, 2001 supply agreement second amendment.    (We shall refer

to such $5 million increase as the $5 million increase in peti-

tioner’s annual purchase requirement.)   As a result, petitioner

earned under the March 9, 2001 supply agreement second amendment

a sales rebate for the annual period ended March 9, 2002, in an

amount equal to the annual payment for that period set forth in

the March 9, 2001 commercial note, and such rebate offset such

annual payment.   For the annual period ended March 9, 2003,

petitioner did not meet the $5 million increase in petitioner’s

annual purchase requirement.   As a result, petitioner earned

under the March 9, 2001 supply agreement second amendment a sales

rebate of $86,573.64 for the annual period ended March 9, 2003,

which was $4,929.19 less than the annual payment for that period

set forth in the March 9, 2001 commercial note.    Such rebate

offset $86,573.64 of such annual payment, and petitioner paid the

balance of such annual payment (i.e., $4,929.19).

     On June 13, 2000, petitioner, which used the accrual method

of accounting, timely filed Form 1120, U.S. Corporation Income

Tax Return (petitioner’s return), for its taxable year ended
                                - 20 -

January 30, 2000.   In that return, petitioner did not include the

$1.5 million at issue in gross income.

     Respondent issued a notice of deficiency (notice) to peti-

tioner with respect to the year at issue.    In the notice, respon-

dent determined that petitioner is required to include the $1.5

million at issue in gross income for that year.

                                OPINION

     Although respondent must have commenced respondent’s exami-

nation of petitioner’s return for the year at issue after July

22, 1998, the parties do not address section 7491(a).16    In any

event, we need not decide whether the burden of proof shifts to

respondent under that section.    That is because resolution of the

issue presented here does not depend on who has the burden of

proof.

     The parties’ sole dispute is whether the $1.5 million at

issue constitutes a loan that is includable in petitioner’s gross

income for the year at issue.

     The determination of whether a transfer of funds constitutes

a loan is a question of fact.     Haber v. Commissioner, 52 T.C.

255, 266 (1969), affd. per curiam 422 F.2d 198 (5th Cir. 1970).

In order for a transfer of funds to constitute a loan, at the

time the funds are transferred there must be an unconditional



     16
      All section references are to the Internal Revenue Code in
effect for the year at issue.
                              - 21 -

obligation (i.e., an obligation that is not subject to a condi-

tion precedent) on the part of the transferee to repay, and an

unconditional intention on the part of the transferor to secure

repayment of, such funds.   Haag v. Commissioner, 88 T.C. 604, 616

(1987), affd. without published opinion 855 F.2d 855 (8th Cir.

1988); see also Frierdich v. Commissioner, 925 F.2d 180, 185 (7th

Cir. 1991), affg. T.C. Memo. 1989-393; Clark v. Commissioner, 18

T.C. 780, 783-784 (1952), affd. per curiam 205 F.2d 353 (2d Cir.

1953).   Whether a transfer of funds constitutes a loan may be

inferred from objective characteristics surrounding the transfer,

including the presence or absence of a debt instrument, collat-

eral securing the purported loan, interest accruing on the

purported loan, repayments of the transferred funds, and any

attributes indicative of an enforceable obligation to repay the

funds transferred.   See, e.g., Haag v. Commissioner, supra at

615-616 & n.6.   In determining whether a transfer of funds

constitutes a loan, the substance, and not the form, of the

transaction is controlling for tax purposes.   See, e.g., Knetsch

v. United States, 364 U.S. 361, 365-366 (1960).

     In support of its position that the $1.5 million at issue

constitutes a loan, petitioner argues:

          The advance from Super Rite on April 15, 1999
     created an unconditional obligation to repay those
     funds. It was only a condition subsequent, i.e. ful-
     filling the obligations under the Supply and Require-
     ments Agreement, on an annual basis, that gave rise to
     the forgiveness of the annual debt service payment.
                        - 22 -

   *       *       *       *       *       *       *

     In the instant case, Petitioner has demonstrated
that all the indicia of a loan as well as a true
creditor-debtor relationship existed. A Promissory
Note was signed * * *; the Note called for interest on
the unpaid balance at the rate of prime plus 1% * * *;
the Note was to be repaid in six annual payments of
$250,000 each commencing on April 16, 2000 and continu-
ing on the third Friday of each April thereafter
through and including April 16, 2005 * * * the Peti-
tioner granted Super Rite a security interest in
(i) all inventory, (ii) all accounts, (iii) all equip-
ment, including without limitation, all machinery,
equipment, furnishings and fixtures of any kind and
nature and description, and (iv) all proceeds of the
foregoing * * *; Petitioner recorded the $1.5 million
Promissory Note as a long term note payable * * *; at
the time of the transaction, Petitioner considered the
$1.5 million as a loan * * *

   *       *       *       *       *       *       *

     There was no guarantee in April of 1999 that the
Petitioner would meet the purchase obligations or other
obligations under the Supply and Requirements Agree-
ments for the ensuing six years. Accordingly, there
was no guarantee that the future debt service payments
would be forgiven. Without any guarantee that Peti-
tioner would be allowed to keep the funds, there is no
income from the loan unless and until such time a debt
service payment is forgiven. “In determining whether a
taxpayer enjoys ‘complete dominion’ over a given sum,
the crucial point is not whether his use of the funds
is unconstrained during some interim period. The key
is whether the taxpayer has some guarantee that he will
be allowed to keep the money.” C.I.R. v. Indianapolis
Power & Light Company, 493 U.S. 203, 110 S. Ct. 589.

     If Super Rite had filed for bankruptcy, the Supply
and Requirements Agreement could be canceled * * *.
Had Super Rite declared bankruptcy, they [petitioner]
would have been under default under the Supply and
Requirements Agreement and accordingly, all amounts due
under the Note would have been immediately due and
payable. If the Petitioner was unable to meet their
payment obligations * * * under the Supply and Require-
ments Agreement and such default remained uncured for a
period of 30 days, Super Rite could cancel the Agree-
                              - 23 -

     ment * * * and as a result of such default, amounts due
     under the Note would immediately become due and pay-
     able. [Reproduced literally.]

     We turn first to petitioner’s related arguments (1) that the

$1.5 million advance by Super Rite to petitioner created an

unconditional obligation on the part of petitioner to repay those

funds and (2) that only a condition subsequent (i.e., compliance

by petitioner with the April 16, 1999 supply agreement) gave rise

to the forgiveness of the annual payment set forth in the April

15, 1999 note.   In advancing those arguments, petitioner relies

on Erickson Post Acquisition, Inc. v. Commissioner, T.C. Memo.

2003-218, and on the following language in the April 15, 1999

note:

          The principal balance of this Note shall be repaid
     in six (6) annual payments of $250,000.00 each, com-
     mencing on April 16, 2000, and continuing on the third
     Friday of each April thereafter through and including
     April 16, 2005; provided however, that the payment of
     the annual payment shall be forgiven by the Lender
     [Super Rite] if the Lender determines that the Borrower
     [petitioner] is in compliance with, and shall not have
     materially breached or then be in uncured default
     under, that certain Supply and Requirements Agreement
     [April 16, 1999 supply agreement] of even date herewith
     among the Borrower and Lender. * * *

     If the form of the April 15, 1999 note were to control, such

form would appear to support petitioner’s arguments.    However, we

are not bound by the form of the April 15, 1999 note.   See

Knetsch v. United States, supra.   The substance of the bargain

between petitioner and Super Rite at the time the $1.5 million at
                              - 24 -

issue was transferred to petitioner governs our resolution of

whether such transfer constitutes a loan.   See id.

     Based upon our examination of the entire record before us,

we find that the substance of the bargain between petitioner and

Super Rite at the time of the transfer to petitioner of the $1.5

million at issue17 was that petitioner’s obligation for a given

annual period to make the annual payment set forth in the April

15, 1999 note would not arise unless and until it materially

breached the April 16, 1999 supply agreement with respect to such

period.   On that record, we find that at the time of the transfer

to petitioner of the $1.5 million at issue petitioner did not

have an unconditional obligation to make each of the annual

payments set forth in the April 15, 1999 note.18   We further find


     17
      Although the April 15, 1999 note is dated Apr. 15, 1999,
it was not until around May 4, 1999, that petitioner received the
$1.5 million at issue. See supra note 10.
     18
      We have found, based on the testimony of Joseph Della Noce
(Mr. Della Noce), an officer of Rich Foods, the parent of Super
Rite at the time of the transaction at issue, that Super Rite
expected that the customer would satisfy the minimum annual
purchase requirement set forth in the supply agreement, but that
Super Rite nonetheless required the customer to execute a note
payable to it in the amount of any advanced funds in order to
facilitate repayment of all or a portion of such funds in the
event that the customer did not satisfy such minimum annual
purchase requirement or otherwise materially breached the supply
agreement. We have also found, based on Mr. Della Noce’s testi-
mony, that Super Rite intended that the customer’s obligation to
repay funds that it advanced to such customer would arise only if
the customer did not satisfy the minimum annual purchase require-
ment set forth in the supply agreement or otherwise materially
breached that agreement.
                             - 25 -

petitioner’s reliance on Erickson Post Acquisition, Inc. v.

Commissioner, supra, to be misplaced.    That case is materially

distinguishable from the instant case.   In Erickson Post Acquisi-

tion, Inc., the Court found that, at the time the taxpayer

received the funds in question, the taxpayer had an unconditional

obligation to repay the full amount of such funds and that “Not

only was the transaction in form a loan but, under the circum-

stances of this case, that was also its substance.”    Erickson

Post Acquisition, Inc. v. Commissioner, supra.    Unlike the

findings of the Court with respect to the obligation of the

taxpayer in Erickson Post Acquisition, Inc., we have found that,

at the time of the transaction at issue, the substance of that

transaction was that any obligation of petitioner under the April

15, 1999 note did not arise unless and until there was a material

breach by petitioner of the April 16, 1999 supply agreement and

that petitioner did not have an unconditional obligation to make

each of the annual payments set forth in the April 15, 1999

note.19

     19
      On the record before us, we reject petitioner’s argument
that certain alleged loan transactions between it and SUPERVALU
that occurred after Super Rite advanced the $1.5 million at issue
to petitioner (subsequent transactions) support its position that
the $1.5 million at issue constitutes a loan. Assuming arguendo
that we had found that the subsequent transactions constitute
loans, those subsequent transactions do not control whether at
the time petitioner received the $1.5 million at issue petitioner
had an unconditional obligation to make each of the annual
payments set forth in the April 15, 1999 note. See Haag v.
                                                   (continued...)
                                  - 26 -

     We turn now to petitioner’s reliance on the statement in

Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203, 210

(1990), that “In determining whether a taxpayer enjoys ‘complete

dominion’ over a given sum, * * * The key is whether the taxpayer

has some guarantee that he will be allowed to keep the money.”

According to petitioner,

          There was no guarantee in April of 1999 that the
     Petitioner would meet the purchase obligations or other
     obligations under the Supply and Requirements Agree-
     ments for the ensuing six years. Accordingly, there
     was no guarantee that future debt service payments
     would be forgiven. * * *

          *         *       *       *       *       *       *

          Even if one assumes that on the anniversary date
     the Petitioner had met the purchase requirements under
     the Supply and Requirements Agreement, there was still
     no guarantee that the debt service payment would be
     forgiven because the Note required “that the borrower
     is in compliance with, and shall not have materially
     breached or then be an uncured default, under the
     Supply Agreement” * * *.

     Petitioner’s contentions in reliance on Commissioner v.

Indianapolis Power & Light Co., supra, miss the point that the

Supreme Court established in that case.      The issue presented in

Indianapolis Power & Light Co. was whether certain deposits that

the taxpayer, a power company, received from its customers were

income.       In resolving that issue, the Supreme Court analyzed

whether the taxpayer enjoyed “complete dominion” over such

     19
      (...continued)
Commissioner, 88 T.C. 604, 616 (1987), affd. without published
opinion 855 F.2d 855 (8th Cir. 1988).
                               - 27 -

deposits.    The Supreme Court held that the taxpayer did not have

“complete dominion” over the deposits in question because it did

not have “some guarantee” that it would be allowed to keep them.

Id.    According to the Supreme Court, by making timely payments of

their respective utility bills, the customers, and not the

taxpayer, controlled whether the taxpayer would be required to

return the deposits that it received from such customers.     Id. at

209.    In contrast to the situation presented in Indianapolis

Power & Light Co., Super Rite did not have control over the

events that petitioner asserts would have constituted a material

breach by it of the April 16, 1999 supply agreement and that

would have required petitioner to repay a portion or all of the

$1.5 million at issue that it received from Super Rite.20    See

       20
      According to petitioner, it would have materially breached
the April 16, 1999 supply agreement upon the occurrence of any of
the following events set forth in paragraph 5 of that supply
agreement:

       (i) upon the failure by the Retailer to make payment to
       Super Rite in accordance with Section 2 hereof for
       goods delivered hereunder; (ii) immediately upon the
       filing of a petition for relief by the Retailer in a
       voluntary proceeding under applicable federal or state
       bankruptcy law or like laws for the protection of
       debtors or upon the application of the Retailer to any
       court or administrative agency of competent jurisdic-
       tion for the appointment of a receiver or trustee for
       the administration of the Retailer’s affairs;
       (iii) upon the filing of a petition for relief with
       respect to the Retailer in an involuntary proceeding
       under applicable federal or state bankruptcy law or
       like laws for the protection of debtors or upon the
       application by a third party to any court or adminis-
                                                     (continued...)
                               - 28 -

id.; see also Herbel v. Commissioner, 106 T.C. 392, 416-417

(1996), affd. 129 F.3d 788 (5th Cir. 1997).   On the record before

us, we find that petitioner had “some guarantee” that, for each

annual period covered by the April 16, 1999 supply agreement and

the corresponding April 15, 1999 note, it would be allowed to

keep the amount of the annual payment set forth in that note as

long as, for each such period, it lived up to its end of the

bargain by not materially breaching the April 16, 1999 supply

agreement.21   See Commissioner v. Indianapolis Power & Light Co.,

     20
      (...continued)
     trative agency of competent jurisdiction for the ap-
     pointment of a receiver or trustee for the administra-
     tion of the affairs of the Retailer, if an order for
     relief shall be entered and continued unstayed in
     effect for thirty (30) days or such petition or appli-
     cation shall continue undismissed for sixty (60) days;
     (iv) following the breach of any obligation of the
     Retailer hereunder, if such breach is not cured within
     thirty (30) days following notice thereof to the
     breaching party; (v) following the default by Retailer
     in the performance of or compliance with any material
     contract, instrument or agreement, including, without
     limitation, any lease of real property, any material
     lease of personal property or any promissory note,
     instrument or agreement evidencing or in respect of any
     indebtedness for borrowed money or any security there-
     for, if such default is not cured within any applicable
     period of grace, or (vi) immediately upon the occur-
     rence of a material adverse change in the condition
     (financial or otherwise), business or prospects of the
     Retailer or any guarantor of the Retailer’s liabilities
     and obligations hereunder. * * *
     21
      On the record before us, we reject petitioner’s contention
that if Super Rite had commenced a bankruptcy proceeding, peti-
tioner would have been in default under the April 16, 1999 supply
agreement. Pursuant to the April 16, 1999 supply agreement, the
                                                   (continued...)
                                - 29 -

493 U.S. at 209, 212; Herbel v. Commissioner, supra.

     Based upon our examination of the entire record before us,

we find that the $1.5 million at issue does not constitute a

loan.     On that record, we further find that that amount is

includable in petitioner’s gross income for the year at issue.

     We have considered all of the contentions and arguments of

the parties that are not discussed herein, and we find them to be

without merit, irrelevant, and/or moot.

     To reflect the foregoing,


                                      Decision will be entered

                                 for respondent.




     21
      (...continued)
commencement of a bankruptcy proceeding by Super Rite merely
would have granted petitioner the option of canceling the April
16, 1999 supply agreement. Thus, it was within the control of
petitioner, and not Super Rite, to cancel that supply agreement
in the event that Super Rite were to commence a bankruptcy
proceeding.
