                         T.C. Memo. 1995-494



                       UNITED STATES TAX COURT



                   FORETRAVEL, INC., Petitioner v.
           COMMISSIONER OF INTERNAL AL REVENUE, Respondent



     Docket No. 27875-92.                Filed October 12, 1995.



     George W. Connelly, Jr., and Linda S. Paine, for petitioner.

     Lillian D. Brigman and Susan V. Sample, for respondent.




               MEMORANDUM FINDINGS OF FACT AND OPINION

     CLAPP, Judge:    Respondent determined deficiencies in, and

additions to, petitioner's Federal corporate income taxes as

follows:

      FYE                               Additions to Tax
    June 30        Deficiency        Sec. 6661    Sec. 6662

     1989          $1,358,614        $339,654         --
     1990             922,494           --        $184,499
                                 - 2 -

       After concessions by the parties, the issues for decision

are:

       (1)   Whether petitioner is entitled to a deduction for its

fiscal year ended June 30, 1989, in the amount of $1,933,994.10

advanced to solve the financial problems of a dealership.     We

hold that petitioner is so entitled.

       (2)   Whether petitioner is entitled to exclude from gross

income, or deduct under section 162, in its fiscal years ended

June 30, 1989, and June 30, 1990, the respective amounts of

$1,160,673.58 and $2,510,135.98 as incentives to its dealerships.

We hold that petitioner is entitled to exclude the respective

amounts from gross income.

       (3)   Whether petitioner is liable for an addition to tax

pursuant to section 6661 for its fiscal year ended June 30, 1989.

We hold that petitioner is not.

       (4)   Whether petitioner is liable for an addition to tax

pursuant to section 6662 for its fiscal year ended June 30, 1990.

We hold that petitioner is not.

       All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated.

                           FINDINGS OF FACT

       Some of the facts are stipulated and are so found.   We
                               - 3 -

incorporate by reference the stipulation of facts and attached

exhibits.

Background

     Petitioner is Foretravel, Inc. (Foretravel), a corporation

organized in 1968 under the laws of the State of Texas, with its

principal place of business in Nacogdoches, Texas.    During the

years in issue, petitioner filed its tax returns on a June 30

fiscal year basis.   Petitioner manufactured and sold class A

self-contained motor homes (coaches) ranging from 29 to 40 feet

in length.   Petitioner sold its coaches under the trade names of

Grand Villa and Unihome.   The Grand Villa sold for retail prices

from $103,000 to $245,000, while the Unihome sold for retail

prices from $172,000 to $310,000.

     Foretravel personnel included the following:    Clarence M.

Fore (Mr. Fore), president; Don Franklin (Franklin), vice

president and chief financial officer; James Don Moore (Moore),

vice president and general manager; Ruth Marie Fore (Mrs. Fore),

secretary and treasurer; Bill Weaver (Weaver), comptroller and

assistant treasurer; and Floyd Wilcox (Wilcox), director of

marketing operations.   Mr. Fore spent his time designing and

selling coaches, while Moore essentially ran petitioner's

operations until his death in 1993.

     Mr. Fore built his first motor home in his spare time in

1967 and incorporated Foretravel one year later to manufacture
                                - 4 -

motor homes.   Foretravel remained a family business until 1971,

when Mr. Fore, along with his friend Moore, quit their jobs and

went to work full time for Foretravel.    Franklin also joined

Foretravel about that time, and Foretravel began advertising in

travel magazines while the Fores attended recreational vehicle

shows to display Foretravel coaches.    As petitioner's coaches

began to gain popularity, its salespeople sold coaches to

existing vehicle dealerships and directly to customers.    By 1977,

35 to 45 dealers were selling Foretravel coaches, and Foretravel

was making approximately 500 coaches a year.    From its inception,

petitioner sought to build a high quality coach with top quality

components.    Petitioner carved out its market niche of expensive,

high quality coaches for the affluent traveler who enjoyed

extended vacations.   Petitioner sponsored regional clubs that

offered courses in motor home maintenance and organized domestic

and international caravans for motor home owners.    During the

years in issue, the Foretravel Motorcade Club had over 2,000

active members.

     Petitioner suffered setbacks in the late 1970s due to the

1978 "energy crunch" and high interest rates.    These factors also

affected independent dealers' interest in stocking Foretravel

coaches and, as a result, only two independent dealers continued

to sell Foretravel coaches.   Petitioner's sales fell below the

anticipated level of production, and petitioner had to lay off
                                - 5 -

employees.    Petitioner decided to become more involved at the

dealer level and, in 1979, petitioner took over a dealership in

California (the California dealership) that owed petitioner

money.

     The Fores traveled to California to run the California

dealership, and they managed to boost sales from 3 coaches a

month to over 20 a month.    The Fores continued to operate the

California dealership until the middle of 1980 when they returned

to Nacogdoches, Texas.    Due to the success of the California

dealership, petitioner purchased other dealerships in Texas,

Tennessee, and Florida.    In each case, these other dealerships

were existing businesses that sold other vacation vehicles, such

as trailers and inexpensive motor homes, in addition to selling

Foretravel coaches.    The California dealership was the only

dealership suffering financial problems when purchased by

petitioner.

     By 1989, petitioner owned 100 percent of the stock of

Foretravel of Arizona, Inc. (the Arizona dealership), but the

Arizona dealership closed in 1989 following a change in Arizona

State law.    Petitioner also owned 100 percent of the stock of

Investments in General, Inc. (IIG).     IIG had four wholly owned

subsidiaries:    Foretravel of California, Inc. (the California

dealership); Foretravel of Florida, Inc. (the Florida

dealership); Murphy Motor Manors, Inc. (the Tennessee
                               - 6 -

dealership); and Foretravel of Texas, Inc. (the Texas

dealership), which apparently included two separate dealerships,

one located in Dallas and the other located in Nacogdoches.    We

refer to the dealers collectively as subsidiaries or dealerships.

Moore served as president of the subsidiaries and the Arizona

dealership.   IIG owned the dealerships' stock because petitioner

wished to avoid the appearance that it sold its coaches through

factory-owned dealers.   IIG and the subsidiaries filed

consolidated returns in 1989 based on a December 31 calendar

year.   In 1990, IIG was liquidated, and petitioner acquired the

dealerships' stock.   The subsidiaries filed separate returns in

1990 based on a calendar year ending December 31.

The Pacific Northwest Dealership

     In 1980, Walter P. Nicholson (Nicholson) and William H.

Fishfader (Fishfader) became partners in a Toyota agency in Coeur

d'Alene, Idaho, where they sold motor homes, recreational

vehicles, and automobiles.   In 1983, they decided to sell

recreational vehicles full time and became interested in the

Foretravel product line.   They contacted a Foretravel

representative on the West coast and eventually signed a dealer

agreement with Foretravel on August 15, 1983, that enabled them

to be the exclusive dealer of Foretravel products for a 5-year

period in Idaho, Montana, Oregon, and Washington.   Pursuant to

the agreement, Fishfader and Nicholson also could sell less
                                - 7 -

expensive product lines but not product lines that would compete

directly with Foretravel.    The resulting dealership was named

Pacific Northwest Motorhomes (Northwest).    Northwest stocked at

least one line of motor homes other than Foretravel.

     The agreement between petitioner and Northwest provided that

they were "independent contractors as to each other and not

otherwise".   The agreement required petitioner to deliver three

units per quarter, and required Northwest to maintain an

inventory of parts and accessories and an inventory of coach

models in a clean and orderly condition.    The agreement also

required Northwest to maintain a regular place of business and

display units for sale while promoting and advertising Foretravel

within Northwest's established territory.    The parties modified

the original agreement to require Northwest to purchase 12 units

in the first year, 18 units the second year, and 24 units for the

remaining 3 years.    Petitioner did not perfect a security

interest under Idaho law in the units shipped to Northwest on

credit.

     Between 1983 and 1985, Northwest grew rapidly, added a

second location, and soon became one of the largest dealers in

that geographic region for high quality coaches.    In 1985,

Fishfader became interested in another dealership in Spokane,

Washington, so he and Nicholson made arrangements to purchase the

Spokane dealership.
                                 - 8 -

     Fishfader had become disillusioned with the expense and time

that it took to sell the higher quality coaches such as those

manufactured by Foretravel.   Fishfader wanted to drop the entire

Foretravel line of coaches and focus on selling a higher volume

of the less expensive coaches.    Nicholson felt that focusing

entirely on less expensive coaches would be a mistake, and he

wanted to continue selling the Foretravel line.     Fishfader and

Nicholson were unable to agree on whether to drop the Foretravel

line of coaches and, in 1985, Fishfader asked Nicholson to

purchase his interest in Northwest.      Nicholson did not have the

funds to purchase Fishfader's interest, so he approached

petitioner and asked for financial assistance.

     Petitioner had established similar relationships in the past

and had recently acquired the Arizona dealership, but petitioner

was not looking for additional company-owned dealerships.

Nonetheless, Nicholson persuaded petitioner that Northwest was

doing an excellent job, and that it would not be in petitioner's

best interest for Northwest to drop the Foretravel product line.

Petitioner concluded that, if it did not assist Nicholson, there

would no longer be a Foretravel dealer in that region.

     On August 30, 1985, petitioner agreed to purchase

Fishfader's 51-percent interest in Northwest for $27,017.

Several weeks later, petitioner and Nicholson entered into a

repurchase agreement (the repurchase agreement) which provided
                               - 9 -

that Northwest would issue 1,000 shares of class B common stock

to be purchased by petitioner for $1,000.   At the end of 3 years,

Nicholson was granted an option to repurchase petitioner's 51-

percent stock holdings of class A common stock at book value if

petitioner's loans to Northwest had been repaid and corporate

debts guaranteed by petitioner had been paid.    Nicholson viewed

petitioner's ownership of the Northwest stock as a temporary

arrangement because he intended to purchase the stock back from

petitioner in a very short time.   Petitioner granted Nicholson a

further option to buy the shares of class B stock from petitioner

at the end of 10 years for $1,000 plus interest, but only if

Northwest had repurchased petitioner's class A stock.    Petitioner

also lent Northwest $22,983 to be repaid over 10 years.    In a

separate agreement dated September 9, 1985, petitioner and its

officers guaranteed the floorplan of Northwest up to $1.2 million

financed by Idaho First National Bank (Idaho First).    Prior to

this time, Fishfader had guaranteed Northwest's floorplan.    Idaho

First also required petitioner to pledge as additional collateral

a certificate of deposit in the amount of $150,000.

     A floorplan arrangement works as follows.   The dealership

wanting coaches for inventory makes the necessary arrangements

with a lender.   When the dealership orders a coach, the

manufacturer contacts the lender for approval to ship the coach

to the dealership.   Title documents are sent through the banking
                                - 10 -

system to the lender, who then pays the manufacturer.     The lender

retains title to the coach.   The dealership owes interest on the

amount financed by the lender until the coach is sold.     When the

dealership sells the coach, the dealership pays the lender the

amount financed, and the difference between the dealership's cost

and the sale price is the dealership's profit.

     In March 1988, Northwest arranged to have Chrysler First

Wholesale Credit, Inc. (Chrysler First), finance its floorplan.

Chrysler First no longer required petitioner's officers

personally to guarantee the financing arrangement, and it did not

require petitioner to pledge the $150,000 certificate of deposit

as additional collateral.   Petitioner remained the sole guarantor

of Northwest's floorplan financing.      The Chrysler First guarantee

agreement provided that the obligation of the guarantor,

petitioner, was primary and was a guarantee of payment, not of

collection.   Therefore, Chrysler First could proceed against the

guarantor jointly or severally without having commenced any

action against or having obtained any judgment against the

obligor, Northwest.

     In the spring of 1988, Northwest's sales began to slow down.

Other high-quality coach manufacturers began to offer deep

discounts on their new coaches, selling at cost or below cost in

an attempt to move inventory.    This competition affected

Northwest's sales of new coaches.    Northwest also had a large
                               - 11 -

inventory of used coaches that had been taken in as trades.     Used

coach sales also declined, and Northwest suffered cash-flow

problems from the cost to inventory the used coaches.

     As the problems mounted, Northwest used the proceeds from

the sales of coaches to pay the most pressing operating expenses

or floorplan costs rather than floorplan loans, thus rendering

itself "out of trust".   Nicholson admittedly "robbed Peter to pay

Paul".   In April 1988, checks from Northwest payable to

petitioner were rejected by the bank due to insufficient funds;

however, Northwest did eventually pay the checks that were

rejected.    Franklin began contacting Nicholson on a regular basis

about Northwest's accounts payable to petitioner.   Nicholson

pacified Franklin by telling him whatever was needed "to keep

things going" so that Northwest could find a way to pull out of

the slump.   Northwest had a deficit equity of $105,434 on April

30, 1987, which increased to $469,176 on June 30, 1988.    Prior to

October 1988, Northwest's officers included Nicholson as

president, Moore as vice president, Weaver as treasurer, and Mrs.

Fore as secretary; while Nicholson, Mr. Fore, Moore, and Franklin

served on the board of directors.   From the time petitioner

purchased Fishfader's stock in Northwest through the fall of

1988, Nicholson managed Northwest, and petitioner exerted no

control over Northwest and did not dictate Northwest's policy.

     By late September or early October 1988, Nicholson had
                              - 12 -

stopped sending financial statements to Chrysler First

consistently.   Chrysler First requested and received Northwest's

financial statement and realized that Northwest's liabilities far

exceeded its assets.   Chrysler First notified Nicholson and

threatened to close Northwest and take over the remaining assets.

Neither Nicholson nor Northwest had the funds to pay Chrysler

First and, in October 1988, Nicholson contacted Franklin and told

him that Northwest was in trouble because he was "out of trust".

Nicholson used proceeds from sales of consigned coaches, as well

as coaches sent by petitioner, to pay operating expenses instead

of paying the consignee or petitioner.     Chrysler First called

Franklin and told him that petitioner, as guarantor, would have

to make good on the lines of credit.

     Franklin and Wilcox traveled to Coeur d'Alene, Idaho, to

assess the situation at Northwest.     Northwest had no record of

its coach inventory, its parts inventory was overstated and

disorganized, and the administrative offices were in disarray.

After 3 or 4 days in Idaho, Wilcox and Franklin returned to

Nacogdoches, Texas.

     Chrysler First demanded $345,000 immediately, and on October

10, 1988, petitioner agreed to lend Northwest $345,000, which

Northwest applied to the Chrysler First loan guaranteed by

petitioner.   Moore, in his capacity as vice president of

Northwest, gave petitioner a 1-year, interest-bearing promissory
                               - 13 -

note dated October 11, 1988, in the amount of $345,000.    The

promissory notes that Northwest gave to petitioner required that

interest at the rate of 10 percent per annum be paid in full

annually.    According to the information available as of October

18, 1988, Northwest owed petitioner $1,019,176.50, and Moore,

acting as vice president of Northwest, gave petitioner a 1-year,

interest-bearing promissory note dated October 18, 1988, in that

amount.

     Wilcox returned to Coeur d'Alene, Idaho, in November 1988 to

install petitioner's accounting system at Northwest, which took

approximately 6 weeks.   During that time, Wilcox discovered that

Northwest owed more money to Chrysler First.   After Wilcox and

Nicholson met with Chrysler First personnel in Seattle,

Washington, Wilcox requested an additional $385,000 from

petitioner to pay Chrysler First pursuant to petitioner's

guarantee.   On November 3, 1988, petitioner agreed to lend

Northwest an additional $385,000, and Moore, acting as vice

president of Northwest, gave petitioner a 1-year, interest-

bearing promissory note dated November 4, 1988, for that amount.

     While establishing an accounting system for Northwest,

Wilcox closed old accounts, opened new ones, and placed various

financial controls on Northwest's future operations.    Wilcox

closed four of Northwest's five existing bank accounts, and the

fifth was used as a depository account to which Nicholson did not
                              - 14 -

have access.   Wilcox opened a working fund account with a

separate bank, and if Nicholson needed money from the working

fund, he would need petitioner's approval for the expenditure.

     Wilcox asked Nicholson for additional assets to secure

petitioner's receivables, but Nicholson had none to pledge, other

than his stock in Northwest and his rights in two patents.    By

this time Nicholson's house and car were highly leveraged, and he

had a minimal balance in his checking account.   Nicholson

delivered his Northwest stock to petitioner as collateral for

petitioner's receivables.   In an auditor's report dated August

21, 1989, petitioner's accountant recorded this transaction as a

purchase of the remaining 49 percent of issued and outstanding

Northwest voting stock from Nicholson on November 1, 1988, but

the accounting record does not disclose any purchase price.

Nicholson also transferred his patent rights to petitioner, but

those rights proved to be of no value.

     Petitioner continued to ship coaches to Northwest, and all

of the units were shipped on credit, with the cost of the unit

carried on petitioner's books as a units account receivable.    The

value of approximately seven units that petitioner shipped to

Northwest before October 28, 1988, was included as part of

petitioner's bad debt deduction for 1989.   Most of the units that

petitioner shipped to Northwest from October 28, 1988, through

June 30, 1989, were written off as bad debts by petitioner on
                                - 15 -

June 30, 1989 as follows:

               Date                      Cost written off
              shipped                    by Foretravel

             10/28/88                      $110,950
             11/04/88                       111,967
             11/29/88                        77,537
             12/21/88                       115,088
              1/24/89                       134,140
              1/31/89                       114,650
              2/23/89                       112,385
              3/23/89                       115,318
              6/10/89                        99,075
              6/12/89                        80,494

                            Total:       $1,071,604

Petitioner also shipped to Northwest unit #3332 (cost $196,185)

on November 9, 1988, and unit #3335 (cost $110,270) on November

18, 1988, and Northwest reduced the balance due on unit #3332 by

$31,255 and paid for unit #3335 in full.    Northwest made these

payments in November 1988.

     In January 1989, petitioner sent Pam Clark (Clark) to

Northwest as a general manager to manage the business side of

Northwest while Nicholson focused on sales.    Northwest's

situation did not improve, and later that same month, Jim Ratliff

(Ratliff), a private investor, demanded payment from Northwest on

a $50,000 note which was not recorded on Northwest's books.

Nicholson had obtained floorplan financing from Ratliff on less

expensive coaches that were too old for Chrysler First to

floorplan.   Nicholson had given Ratliff a note for $50,000

secured by rights in one of Nicholson's patents.      Nicholson never
                               - 16 -

informed petitioner about Ratliff's note.   In January 1989,

Nicholson surrendered ownership of his stock in Northwest to

petitioner.

     On January 8, 1989, Nicholson and petitioner amended the

repurchase agreement.   The amendment provided that petitioner

owned 100 percent of Northwest's stock, and that Nicholson would

regain the 49-percent interest in Northwest when Northwest repaid

petitioner's accounts receivables due from Northwest and repaid

the advances made to Northwest during 1988.   On January 9, 1989,

petitioner agreed to advance Northwest $50,000, and Moore, acting

as vice president of Northwest, delivered a 1-year, interest-

bearing promissory note to petitioner in that amount.   Northwest

repaid petitioner $50,000 on February 22, 1989, but no interest

was paid for the time the note was outstanding.

     In April 1989, Tracy Golden (Golden), a partner from the

accounting firm of Axley & Rode, who had been working on the

Foretravel account since 1983, was performing routine interim

audit work on petitioner's financial statements when he became

concerned that the receivables from Northwest might affect his

ability to express a "clean" opinion on petitioner's financial

statements.   Golden wanted to observe firsthand the situation at

Northwest.    He discussed the matter with Weaver, and they decided

to inspect Northwest and assess the situation.

     On May 23, 1989, petitioner settled a note given to

Fishfader by Northwest.   Petitioner paid Chrysler First
                               - 17 -

$132,390.10 for two Rockwood coaches floorplanned by Chrysler

First.   These coaches were then transferred to Fishfader in

exchange for the note given to him by Northwest.    Moore, acting

as president of Northwest, delivered to petitioner a 1-year,

interest-bearing promissory note dated May 24, 1989, in the

amount of $132,390.10.

     About this same time, late May 1989, Ratliff produced

another note signed by Nicholson, as president of Northwest, in

the amount of $225,000.    Petitioner sent a representative to

Coeur d'Alene, who met with Nicholson and asked him to resign and

not return in any capacity.    Petitioner immediately consulted its

lawyer about what options were available regarding Northwest and

Nicholson.    Petitioner's officers still felt that Northwest was

in a marketable area and had potential for success, despite its

poor financial condition.

     In June 1989, Golden and Weaver made a surprise visit to

Northwest.    They found the parts inventory and parts room in

disarray, and some used coaches were missing while others were in

disrepair.    They also went to Northwest's accountant's office to

inquire about some of the information on Northwest's financial

statements.    The accountant stated that he compiled the financial

statements from the numbers he received from Nicholson and,

previously, Fishfader.    The accountant never inspected bank

statements, check registers, or receipts.
                               - 18 -

      Golden and Weaver took an inventory of motor homes, vans,

and cars, and also inspected some of Northwest's records.

Looking for sources of collection for the amounts that Northwest

owed petitioner, Golden reviewed the assets at the dealership,

and he concluded that Northwest was insolvent to the extent of

roughly $2 million.    Golden's conclusion was contrary to

compilation statements given to petitioner by Northwest the year

before.   Golden and Weaver boxed up as many of Northwest's

records as they could and shipped them back to Nacogdoches,

Texas, for review.    After reviewing Northwest's records in

Nacogdoches, Golden concluded that cash was missing from

Northwest, but he was unable to determine where the cash might

be.   Petitioner did investigate the possibility that Nicholson

had pocketed the cash, but by this time Nicholson had few if any

assets available for collection.

      Axley & Rode analyzed Northwest's assets and liabilities to

determine whether Northwest's receivables were collectible.

After a review of Northwest's records, Golden advised petitioner

that Northwest could not generate the cash-flow needed to pay the

amount owed to petitioner.    Northwest's receivables were pledged

to the finance company, new inventory of coaches not manufactured

by petitioner ("X" brand coaches) was floorplanned by Chrysler

First, and the value of the used coaches was inflated.    The total

assets on the books were $1,096,491 and liabilities were $3.5
                                - 19 -

million, of which $2.4 to $2.5 million was owed to petitioner.

Northwest had lost $1,663,189 in its year ended December 31,

1988, and through June 1989 had lost approximately $600,000.

After Golden had the Axley & Rode tax department research the

question, he advised petitioner to deduct the Northwest

receivables as a bad debt.

     By the end of June 1989, petitioner believed that Northwest

could not pay, and did not have the potential to pay, the

existing receivable balances.    Mr. Fore was concerned that

Northwest's situation could cause bad publicity among potential

customers and have a negative impact on petitioner.

     On June 30, 1989, petitioner wrote off as a bad debt the

following items attributable to Northwest:    Trade accounts

receivable in the amount of $54,438.13, which included

advertising, insurance, and other expenses that petitioner paid

on Northwest's behalf; notes receivable in the amount of

$885,373.10; and unit accounts receivable in the amount of

$1,758,847.50.   The notes receivable in the amount of $885,373.10

consisted of the note dated October 11, 1988, in the amount of

$345,000, the note dated November 4, 1988, in the amount of

$385,000, and the note dated May 24, 1989, in the amount of

$132,390.10.   The remaining $22,983 in the notes receivable

account consisted of the loan to Northwest in 1985 when

petitioner acquired 51 percent of Northwest's stock.
                              - 20 -

     Northwest recorded as income on its books the amount of

petitioner's bad debt writeoff.   After June 30, 1989, petitioner

did not receive any other assets, cash, or property owned or on

the books of Northwest as of June 30, 1989.    Funds that

petitioner received from Northwest after June 30, 1989, were

attributable to units delivered to Northwest after June 30, 1989.

Foretravel Incentive Program for Dealerships

     Petitioner established uniform bookkeeping systems for the

subsidiaries, and the subsidiaries also used standard paperwork,

including forms distributed by the Recreational Vehicle Dealer

International Association.   The dealerships were retail merchants

that sold and serviced new motor homes, including those

manufactured by Foretravel, less expensive motor homes, used

motor homes, trailers, and other service recreational vehicles.

Each dealership carried at least one "X" brand line of motor

homes.

     Motor home manufacturers use a variety of incentive plans

designed to promote the sale of their products.    Petitioner was

no exception.   Through its incentive program, petitioner sought

to maintain a steady flow of coaches through its manufacturing

operation, thus avoiding fluctuations in employment, supplies,

and general level of operation.   Petitioner also sought to obtain

positive publicity from its customers, maintain customer

goodwill, alleviate cash-flow problems, and maintain its
                              - 21 -

reputation as a top quality coach manufacturer.    Petitioner also

used its incentive program to attract buyers for coaches with

unpopular colors or unpopular sizes and display models that had

been driven to recreational vehicle shows.    The "X" brand

manufacturers also offered incentive programs to the Foretravel

dealerships.

     One facet of petitioner's incentives began when Mr. Fore

operated the California dealership.    The California dealership

would purchase Foretravel coaches for sale to customers.      At

times, customers would make Mr. Fore an offer on a Foretravel

coach, but the purchase price proposed by the customer would be

less than the price the California dealership paid petitioner for

the coach.   Mr. Fore would call Moore at Foretravel and ask him

if petitioner was interested in such a sale.    If petitioner was

interested in selling the coach at the customer's suggested

price, then petitioner would make a commensurate adjustment in

its price to the dealer via the Foretravel incentive program.

This incentive method still was in place during the years in

issue and was available to a dealer faced with a customer offer

that produced a loss or resulted in a "skinny deal".

     A "skinny deal" is a transaction that has a $3,000 profit or

less.   A salesperson at the dealership could not turn down any

deal proposed by the customer, even a skinny deal.    The sales

manager at the dealership had the authority, as did the general
                              - 22 -

manager, to accept any deal with a profit in excess of $3,000.

When the profit fell below $3,000, the dealership had to contact

Foretravel in Nacogdoches to approve the transaction.    Franklin

or Moore personally had to approve any loss transaction.    If a

used coach was taken in as a trade on the purchase of a

Foretravel coach, then neither petitioner nor the dealership knew

the exact profit or loss until the used coach was sold and, even

then, another used coach might be taken in as a trade.

Difficulty in predicting the resale value of a used coach added

to the uncertainty.   Thus, petitioner made one yearend rebate

instead of making an immediate rebate that might have to be

reversed after the sale of the used coach.   To maintain a steady

flow of coaches, petitioner would force dealers to accept

inventory so as to avoid the circumstances that petitioner faced

in 1979, when some of the independent dealers refused to accept

new inventory.   This refusal interfered with petitioner's ability

to maintain steady production.   Petitioner provided the

dealerships with floorplan financing in 1989 and 1990, and

petitioner charged the dealerships interest on this financing.

Thus, the additional inventory would result in additional finance

costs for the dealer.   Petitioner would take the additional

inventory and associated finance costs into account when

determining the incentives owed to a dealer.

     To obtain positive publicity from its customers, petitioner

would authorize a special deal on a coach for a high profile
                                - 23 -

motor home owner, such as a leader or organizer of a motor home

association or club.   Petitioner felt that having that person own

a Foretravel coach could influence other members of that

association or club to do the same.      To maintain customer

goodwill, petitioner would authorize a special deal or a

favorable trade on another Foretravel model when a customer

returned a coach and complained of poor quality.      To alleviate

temporary cash-flow problems, petitioner might allow a dealer to

sell a new or used coach financed by petitioner at a discount in

order to generate cash-flow to petitioner.      To maintain its

reputation as a top quality or "highline" coach manufacturer,

petitioner established relatively high wholesale and suggested

retail prices.   The yearend incentive payments allowed petitioner

to maintain its position in the public's eye as a top quality

coach manufacturer while reducing the wholesale cost of the coach

to the dealer when necessary.    Petitioner also believed that a

firm wholesale price provided salespeople with a floor that they

could use to negotiate with customers.

     Petitioner took all of the various factors discussed above

into account when determining the incentive payment for the

dealerships.   Petitioner had no written policy as to the amount

of the incentive paid to each dealer.      Franklin and Moore

discussed throughout the year the various transactions that would

give rise to a rebate.   At the end of petitioner's fiscal year,

Franklin again discussed the various transactions with Moore, and
                               - 24 -

then Moore would decide the amount of the rebate to each dealer.

     Petitioner also paid incentives to independent dealers that

sold Foretravel coaches, but those incentives were not

necessarily identical to the incentives paid to petitioner's

subsidiaries.   The incentives petitioner paid to the various

subsidiaries were not necessarily identical either, in part

because sales fluctuated both seasonally and geographically.

Petitioner offered the incentives needed to spur sales at the

particular time.

     The dealer incentives for the years in issue were as

follows:

                           Rebate for year ended June 30
     Dealer                       1989           1990

     Arizona                  $22,005.18           --
     California               231,145.18     $404,321.45
     Dallas                    10,488.94      953,748.93
     Florida                  191,089.37      696,004.99
     Tennessee                336,683.04      456,060.61
     Nacogdoches              369,261.87           --

           Total:          $1,160,673.58   $2,510,135.98

     For 1989, Weaver recorded the incentive payments as a credit

to trade accounts receivable and a debit to bad debts on

petitioner's books.    Weaver recorded the incentive payments as a

debit to the bad debts account because he was stretched for time

and took a shortcut.    He knew that the auditors from Axley & Rode

would reclassify or make an adjustment to the entries where

appropriate.    In 1989, Moore directed Weaver to record the

incentive payments as a credit to trade accounts receivable from
                              - 25 -

the subsidiaries, because Moore felt that this would be

advantageous to petitioner for financial reporting purposes.

This resulted in a writeoff of the entire balance of petitioner's

trade account receivables for the fiscal year ended June 30,

1989.

     For 1990, Weaver recorded the incentive payments as a credit

to unit receivables and a debit to bad debts on petitioner's

books.   Moore did not instruct Weaver how to record the incentive

payments for 1990.   Weaver believed the credit to unit

receivables was the correct entry on petitioner's books because

the incentive was being matched to the sales of units as

reflected in the unit receivables.     He thought a journal entry

debiting sales, which petitioner had done in prior years with a

credit memo, would not be proper without a credit memo.

     Golden supervised Axley & Rode's preparation of petitioner's

financial statements for its fiscal years ended June 30, 1989,

and 1990.   Even before he became managing partner of the

Foretravel account in 1987, Golden knew that petitioner had a

rebate policy.   After the audit group from Axley & Rode completed

the financial statements, the relevant information was turned

over to Axley & Rode's tax department to prepare the tax returns.

Golden then reviewed the completed tax returns.

     For the years in issue, Golden was aware that the account

Weaver labeled as bad debts also contained the rebates to the

various dealerships.   Golden treated the bad debt account as a
                              - 26 -

suspense account that needed to be adjusted later in order to

reclassify the rebates.   Golden did not reclassify the incentive

payments for financial accounting purposes because he felt that

doing so would not change the consolidated financial statements

prepared by Axley & Rode.   Golden failed to reclassify the

rebates, and when the Axley & Rode tax department prepared

petitioner's Federal corporate income tax returns, nothing

indicated that rebates to the dealers existed.   When Golden

reviewed the completed tax returns, he compared the results with

preliminary calculations he made using the financial statements,

but he failed to notice that the incentive payments had not been

reclassified.   Weaver reviewed petitioner's Federal corporate

income tax returns for the years in issue, but he failed to

realize that Axley & Rode had not reclassified the incentive

payments.   As a result, petitioner reported the rebates as bad

debts on its tax returns for the years in issue.   The incentive

payments were booked on the subsidiaries' financial statements

for the years 1989 and 1990 as other income.   For the years in

issue, the subsidiaries reported the incentive payments as income

in an amount equal to the bad debt deductions taken by

petitioner.

                              OPINION

Deduction for Payments Made in Connection With Northwest

     The differences between the parties come down to a basic

difference in the analysis and interpretation of the events that
                                - 27 -

transpired between petitioner and Northwest during the fiscal

year ended June 30, 1989.    Respondent looks at the events during

this period, and particularly the advances made by petitioner to

Northwest, as being either loans which created debt or

contributions to capital.    Respondent views petitioner as a

stockholder of Northwest and analyzes the advances by petitioner

to Northwest under the traditional debt-equity considerations.

See Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir.

1972) (applying 13 debt-equity factors).      Using that approach,

respondent concludes that no bona fide debtor-creditor

relationship between petitioner and Northwest was created after

October 10, 1988, because the advances and extensions of credit

by petitioner to Northwest after that date were worthless when

made.     See Putnam v. Commissioner, 352 U.S. 82, 88 (1956)

(taxpayer who voluntarily buys a debt with knowledge that he will

not be paid is considered not to have acquired a debt).

        Petitioner, on the other hand, views the transactions during

this period as an attempt to bail out and salvage a dealership

that was important to petitioner.    Northwest covered a territory

which had substantial potential.    Prior to the years in issue,

Northwest had been profitable and responsible for many sales of

petitioner's motor coaches.    Petitioner wanted to keep Northwest

as a healthy, profitable dealership because of its own self-

interest in selling motor coaches.       As the scenario further

developed and the bankruptcy of Northwest became a real
                              - 28 -

possibility, petitioner was seriously concerned about the effect

that this development would have on its reputation among owners

and potential owners of Foretravel coaches.   Petitioner's

original acquisition of 51 percent of the stock of Northwest from

Fishfader was made in order to keep Northwest in existence.     The

51-percent ownership was not intended to be permanent; it was

expected that the stock would be sold to Nicholson and that

petitioner would be out of the picture in terms of stock

ownership.   As the facts set forth above indicate, this did not

happen.   In fact, the situation went the other way, and Nicholson

began to develop financial problems.   Petitioner's officers

believed in their best business judgment that petitioner should

advance cash to Northwest to help Northwest stay viable.     As the

situation developed, matters went from bad to worse, all as

outlined above.   Petitioner continued to respond to each new

crisis with more cash for the reasons already set forth.

Petitioner got into the Northwest situation deeper and deeper as

problems developed.   Petitioner argues that the advances made

were for the purpose of bailing out and salvaging Northwest, all

for the business purposes and best interests of petitioner.

Petitioner also argues that the amounts advanced to Northwest

should be deductible either as bad debts or as uncollectible

accounts receivable, or some combination thereof, without regard

to the usual criteria for creating a debt.
                              - 29 -

     Respondent concedes that the debts associated with Northwest

and accrued by petitioner prior to October 10, 1988, are

deductible as bad debts.   Respondent argues that the funds

advanced and the units shipped after October 10, 1988, were

capital contributions.   Thus, of the $2,698,658.73 bad debt

deduction taken by petitioner for the year ended June 30, 1989,

only $1,933,944.10 remains in dispute.   The $1,933,944.10

consists of the note given to petitioner by Northwest dated

October 11, 1988, in the amount of $345,000, the note dated

November 4, 1988, in the amount of $385,000, and the note dated

May 24, 1989, in the amount of $132,390.10, with petitioner's

accounts receivable for units shipped to Northwest after October

11, 1988, making up the balance of $1,071,604.   The parties agree

that all of the amounts due petitioner from Northwest on June 30,

1989, were worthless at that time.

     Section 166(a) provides that there shall be allowed as a

deduction any debt which becomes wholly or partially worthless

within the taxable year.   The taxpayer bears the burden of

proving entitlement to a claimed bad debt deduction.   Rule

142(a); Crown v. Commissioner, 77 T.C. 582, 598 (1981).

     We must evaluate whether there was a genuine intention to

create a debt, with a reasonable expectation of repayment, and

whether that intention comports with economic reality.     Litton

Business Sys., Inc. v. Commissioner, 61 T.C. 367, 377 (1973);
                                - 30 -

Baldwin v. Commissioner, T.C. Memo. 1993-433.    In making this

determination we will not ignore the realities of the business

world.    Santa Anita Consol., Inc. v. Commissioner, 50 T.C. 536,

550 (1968); C.M. Gooch Lumber Sales Co. v. Commissioner, 49 T.C.

649, 656 (1968), remanded pursuant to stipulation of the parties

406 F.2d 290 (6th Cir. 1969).    We agree with petitioner's

analysis of what happened and decline to substitute respondent's

different business judgment.

     Our first point of departure from respondent's analysis is

the significance given to petitioner's ownership of Northwest's

stock.    Respondent has overemphasized this fact.   Petitioner was

not interested in owning Northwest but agreed to purchase the

initial 51 percent primarily to keep a Foretravel dealer in that

region.    Petitioner and Nicholson entered into a repurchase

agreement giving Nicholson the option after 3 years to repurchase

petitioner's 51-percent stock holdings.    In November 1988,

Nicholson delivered the remaining 49 percent, along with patent

rights, to petitioner as collateral for petitioner's receivables.

The patent rights proved to be of no value.    Nicholson eventually

surrendered ownership of the remaining 49 percent in January

1989.    Thus, petitioner's ownership of the Northwest stock was by

default rather than by design.

     There is no dispute that petitioner guaranteed the financing

from Chrysler First in the normal course of petitioner's trade or

business of selling motor homes.    A guarantor of a corporate
                               - 31 -

obligation may not deduct the payment to satisfy the guarantee

if, considering the circumstances when the guarantee was created,

the payment constitutes a contribution to capital.    Plantation

Patterns, Inc. v. Commissioner, 462 F.2d 712, 722-723 (5th Cir.

1972), affg. T.C. Memo. 1970-182.    We are satisfied that the

guarantee, originally entered into with Idaho First on September,

9, 1985, was bona fide.    Prior to that date, Fishfader guaranteed

Northwest's financing, and Northwest showed signs of promise.      We

conclude that petitioner's payments pursuant to the guarantee

agreement were properly deducted by petitioner as bad debts.

     Respondent concedes that the transactions before October 10,

1988, created bona fide debts.    We do not agree with respondent

that the debt-equity analysis begins at ground zero on October

10, 1988.    Forcing petitioner to run the entire debt-equity

gauntlet for every transaction after October 10, 1988, is

artificial and ignores the facts of this case.    We focus on the

events that transpired between early 1988 and June 30, 1989.

     In April 1988, Northwest wrote checks payable to petitioner

that the bank rejected due to insufficient funds.    In October

1988, Franklin learned that Northwest was out of trust and that

Chrysler First expected payment from petitioner on the floorplan

guarantee.

     The entire motor home industry suffered a slowdown in the

spring of 1988, as indicated by Northwest's competitors' selling

new coaches at cost or below cost in an attempt to move
                               - 32 -

inventory.    Thus, petitioner could reasonably expect to see

losses surface during this market slowdown.      After learning

about Northwest's financial setbacks, Franklin and Wilcox

traveled to Coeur d'Alene, Idaho, to assess the situation at

Northwest.    After observing some of the fundamental problems at

Northwest, Wilcox returned to Northwest in November 1988 and

placed supervisory and financial controls on Northwest's

operations.    Petitioner obtained additional collateral from

Nicholson, patent rights, and his Northwest stock, and petitioner

sent Clark to Coeur d'Alene so that she could manage the business

side of Northwest.

     We find petitioner's response reasonable especially in light

of the fact that petitioner exerted no management or financial

controls over Northwest prior to the fall of 1988.     Petitioner's

officers decided to assist a dealership that provided an outlet

for petitioner's products in a profitable region.     Petitioner

provided loans to Northwest and applied financial and management

controls over Northwest's operations when additional problems

surfaced.    Petitioner engaged Axley & Rode for advice and

assistance in evaluating Northwest's financial condition.     Given

Northwest's success prior to the market slowdown in the spring of

1988, petitioner reasonably could conclude that Northwest would

be able to pay the amounts advanced.     See Baldwin v.

Commissioner, T.C. Memo. 1993-433.      Petitioner properly deducted

the disputed amounts as bad debts.
                              - 33 -

Foretravel's Incentive Program

     Petitioner argues that the incentive payments to the

dealerships are excludable from gross income, or in the

alternative, are deductible as ordinary and necessary business

expenses.   Respondent argues that in substance petitioner's

incentive payments were contributions to capital and were not

reductions in sales prices or deductible under section 162.    We

agree with petitioner.

     Petitioner concedes that it erroneously claimed the

incentives as bad debts for both years in issue.   This fact is

not fatal to petitioner's claim that the payments were actually

incentive payments where, as here, petitioner provides thorough

and credible evidence showing that the payments were mistakenly

reported as bad debts.   We look at the true nature of the

payments despite the labels and bookkeeping entries used by

petitioner.   B. Forman Co. v. Commissioner, 453 F.2d 1144, 1160

(2d Cir. 1972) affg. in part, revg. in part and remanding 54 T.C.

912 (1970); Burnett v. Commissioner, 356 F.2d 755 (5th Cir.

1966), remanding 42 T.C. 9 (1964).

     Respondent argues that the incentive payments, or rebates,

are not excludable from petitioner's gross income or deductible

expenses because the payments were unrelated to performance, and

there was no set sales volume that the dealer had to meet in

order to qualify for a rebate.   Respondent, citing Sun

Microsystems, Inc. v. Commissioner, T.C. Memo. 1993-467, contends
                               - 34 -

that, in order to qualify as a volume discount, the discount must

be set forth in a formula, and the volume of product to be

purchased in order to qualify for the discount must be specified.

However, the discounts here are not volume discounts.    Many

different arrangements can constitute a reduction in sale price.

Cf. Max Sobel Wholesale Liquors v. Commissioner, 630 F.2d 670,

671-672 (9th Cir. 1980), affg. 69 T.C. 477 (1977); Dixie Dairies

Corp. v. Commissioner, 74 T.C. 476, 489-492 (1980); Haas Bros.,

Inc. v. Commissioner, 73 T.C. 1217 (1980); Tri-State Beverage

Distribs., Inc. v. Commissioner, 27 T.C. 1026, 1029-1031 (1957);

Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707 (1956);

Convergent Technologies, Inc. v. Commissioner, T.C. Memo. 1995-

320.    In Mississippi Chem. Corp. v. Commissioner, 86 T.C. 627,

640 (1986), we noted that the common thread running through Max

Sobel, Dixie Dairies, Haas Brothers, and Pittsburgh Milk is that

there was an agreement between the taxpayer and its customers,

entered into prior to the sale of the product, providing for the

refund of some part of the purchase price.    We are satisfied that

this common thread runs through the rebates paid by petitioner to

its dealers.

       There is no doubt that the various facets of petitioner's

rebate program did not lend themselves to expression by a

numerical formula.    Nonetheless, if the individual factors

separately would qualify as a purchase price reduction, then the

factors taken as a whole would qualify as a purchase price
                                - 35 -

reduction.   Petitioner offered rebates of the finance costs

imposed on a dealer from additional inventory, and also used

incentives to attract buyers for coaches with unpopular colors or

unpopular sizes and display models that had been driven to

recreational vehicle shows.    Petitioner did not offer the rebate

up front to the dealer, but instead sold these coaches to the

dealer at full price and then would accept a lower price from the

dealership if the need arose.    In this circumstance, there was an

understanding between Foretravel and its customers, the

dealerships, entered into prior to the sale of the product to the

ultimate user of the product.    If the dealership could

immediately sell a coach at full retail price despite its

unpopular size or color, it would do so; if it could not, then

the dealership could sell the coach for less than retail with a

commensurate rebate to the dealership approved by petitioner.

     The incentives generated by sales to high profile buyers, or

buyers who complained about the quality of a Foretravel coach,

also qualified as a purchase price reduction between petitioner

and the dealers.   The reality of the marketplace would dictate

the rebate needed to put the product in the hands of the

consumer.    If a high profile buyer offered the dealership full

retail price, then there was no reason for petitioner to reduce

the sale price of the coach to the dealer.    The more reasonable

method was the method used by petitioner and its dealers whereby

petitioner would adjust the price to the dealer via a rebate if
                              - 36 -

necessary, and then the dealer would in turn adjust the retail

price to the consumer.

     The rebates offered to dealers when petitioner was in need

of cash also qualify as purchase price reductions between

petitioner and the dealers.   Petitioner needed cash, and

petitioner had extended credit to the dealer.   Petitioner offered

the dealer a rebate with the general understanding that the

dealer would reduce the retail price to the consumer.    The sale

to the consumer put cash in the dealer's hands, which enabled the

dealer to reduce the credit balance owed to petitioner.

Petitioner's need for cash and the rate of sales at the retail

level, coupled with the price the consumer was willing to pay the

retailer for a coach, would determine the rebate needed, if any,

to put the product into the hands of the consumer.

     These factors highlight why a numerical formula setting

forth the amounts of the rebates may not be practicable in all

instances.   The fact that a dealer may receive a used coach as a

trade exacerbates the uncertainty, because the used coach must be

valued in order to determine the amount realized by the dealer at

the retail level.   The product sold by petitioner is unique, and

the particular rebates needed to move merchandise into consumers'

hands could fluctuate to such an extent that the rebates could be

determined appropriately only on a transaction-by-transaction

basis.   We conclude that petitioner's failure to reduce its

rebate policy into a numerical formula is not fatal to
                              - 37 -

petitioner's claim of a rebate, because petitioner was the sole

manufacturer of a unique product, particular purchasers might be

prospects for a rebate offer from the manufacturer while others

might not, the retail price was subject to negotiation between

the consumer and the distributor, and the demand for the unique

products offered by petitioner fluctuated geographically and

seasonally.

     Petitioner offered detailed testimony setting forth the

factors taken into account in its incentive program and the

objectives it intended to accomplish through its incentive

program, and we conclude that the disputed payments were bona

fide incentive payments made in furtherance of those various

objectives.   We conclude that the incentive payments are

excludable from petitioner's gross income as a reduction in the

sale price of coaches.

     We are mindful of respondent's position that transactions

between related parties should be subject to close scrutiny

because they may engage in transactions that are not arm's

length.   See C.M. Gooch Lumber Sales Co. v. Commissioner, 49 T.C.

at 656; Hall v. Commissioner, 32 T.C. 390, 407 (1959), affd. 294

F.2d 82 (5th Cir. 1961).   Respondent has shown that the incentive

payments by petitioner to its dealers for the year ending June

30, 1989, consisted of the entire balance of petitioner's trade

account receivables recorded on petitioner's books.   However, we

do not consider this conjunction of numbers to be fatal in the
                              - 38 -

year ending June 30, 1989.   We conclude that Moore arrived at the

figure for incentive payments taking into account the many

considerations set forth above.

Additions to Tax

     As a result of our findings above, we need not address the

additions to tax.

     To reflect the foregoing and the concessions by the parties,

                                    Decision will be entered

                               under Rule 155.
