Taxation – Federal Income Tax Deductibility of Interest on Debentures Issues as a Dividend

Taxpayer, a wholly-owned subsidiary corporation, had filed consolidated returns with its parent prior to 1934. When Congress abolished consolidated returns in that year, the subsidiary issued 6% debentures as a dividend to the parent company and subsequently deducted the interest paid on these bonds. The Commissioner claimed the interest payments were really dividends and were not deductible. The Tax Court upheld the Commissioner pointing out the tax-saving motive, absence of new investment, and parent-subsidiary relationship as factors indicating that no genuine debtor-creditor relationship existed. On appeal, held, reversed. The debentures involved were conventional in form and created a valid indebtedness. Kraft Foods Co. v. Commissioner, (2d Cir. 1956) 232 F. (2d) 118.