GM Trading Corp. v. CIR

• Decision Date: 12 September 1997
• Docket Number: No. 96-60679.,96-60679.
• Citation: 121 F.3d 977
• Parties: G.M. TRADING CORPORATION, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

121 F.3d 977

G.M. TRADING CORPORATION, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 96-60679.

United States Court of Appeals, Fifth Circuit.

September 12, 1997.

R. James Curphy, Schoenbaum, Curphy & Scanlan, San Antonio, TX, Jerome B. Libin, Washington, DC, James Preston Fuller, Kenneth B. Clark, Jennifer Lynn Fuller, Rachel Hersey, Kelly Camille Mulholland, Fenwick & West, Palo Alto, CA, Noel Preston Brock, Sutherland, Asbill & Brennan, Washington, DC, for Petitioner-Appellant.

Steven W. Parks, Loretta Argrett, Asst. U.S. Atty. Gen., U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC, Richard Bradshaw Farber, Department of Justice, Tax Division, Washington, DC, Charles Casazza, Clerk, U.S. Tax Court, Washington, DC, Stuart L. Brown, Chief Counsel, Internal Revenue Service, Washington, DC, for Respondent-Appellee.

Before JOLLY, SMITH and DENNIS, Circuit Judges.

JERRY E. SMITH, Circuit Judge:

G.M. Trading Corporation ("G.M.") surrendered $600,000 worth of Mexican national debt to the Mexican government and received approximately 1.7 billion pesos restricted to the construction of a plant in Mexico. The Tax Court found that G.M. recognized $410,000 of gain. Concluding, to the contrary, that the pesos received in exchange for the debt extinguishment were worth $600,000, and the balance of the value received constituted a nontaxable contribution to capital, we reverse and render judgment for the taxpayer.

I.

A.

In the late 1980's, the Mexican government maintained a policy designed to encourage foreign investment and to decrease the outstanding balance of its foreign-currency-denominated debt (the "Program"). The Program had many different incarnations; we need consider only one.

Under "Mecanismo No. 4," a foreign corporation would purchase foreign-currency-denominated debt from a bank and surrender that debt to the Mexican government. For its part, the Mexican government would grant a certain number of pesos to a new Mexican subsidiary of the foreign corporation. Usually, these pesos would be restricted to uses benefiting the Mexican economy. The stock that the foreign corporation received would be subject to restrictions on transfer and dividends.

The number of pesos granted was determined by a set formula. Mexico paid the face amount of the debt retired, discounted by 0% to 25%. Because Mexico was not making interest or principal payments at the time, the market discount on the debt always was higher than 25%.

The particular amount of the discount was calculated "upon the perceived benefit of each proposed investment to the Mexican economy." Specifically, the Mexican government desired to encourage foreign investment, high-technology businesses, and high export production. A 100% foreign investor forming a high-technology business exporting at least 80% of its production would receive a 5% discount.

B.

G.M.¹ is a Texas corporation engaged in the processing of sheep skins. In 1987, G.M. was interested in locating a plant in Acuña, México, and contacted the Mexican government about participating in the Program. The Mexican government approved G.M.'s proposal and, in November 1987, the following transaction (the "Transaction") occurred:

1) For $600,000, G.M. purchased U.S.-dollar-denominated Mexican debt bearing a face value of $1,200,000 from a Dutch bank. The fair market value of this debt at the time was $600,000. G.M. also incurred fees and costs totaling $34,000.

2) G.M. caused that debt to be surrendered to the Mexican government.

3) The Mexican government tendered to Procesos G.M. de México, S.A. de C.V. ("Procesos"), a subsidiary of G.M., 1,736,694,000 pesos restricted to the construction of a sheep skin processing plant in Acuña. The amount of 1,736,694,000 unrestricted pesos would have had a fair market value of $1,044,000.²

These pesos were highly restricted. They could be used only for the purchase of land and the construction and outfitting of an industrial plant in Acuña. The Mexican government controlled the pesos and paid them to vendors directly.

The identity of those vendors also was restricted greatly. For example, Procesos had to employ Mexican companies and use Mexican goods and services in constructing the plant. Procesos could purchase land only from persons willing to reinvest the sale proceeds in México. Until use, the pesos bore interest at the rate for treasury certificates. The interest, unlike the principal, was not restricted.

G.M.'s stock in Procesos was subject to additional restrictions. G.M. could not transfer the stock to a non-Mexican entity until 1998. The stock could not be redeemed on a basis more favorable than the amortization of the debt surrendered. With a minor exception, the stock could not pay guaranteed dividends "irrespective of earnings and profits." Finally, the stock could not be converted into stock that did not contain these restrictions.

C.

G.M. reported no taxable gain on the Transaction. The Commissioner of Internal Revenue (the "Commissioner") determined that G.M. recognized a gain of $601,745³ and issued a notice of deficiency for that amount. G.M. petitioned the Tax Court for a redetermination.

Before the court, the Commissioner argued that G.M.'s gain was $1,044,000 minus $634,000, or $410,000. G.M. continued to argue that it had no taxable gain. The Tax Court adopted the Commissioner's position. See G.M. Trading Corp. v. Commissioner, 103 T.C. 59, 1994 WL 386151 (1994). The court granted rehearing and then affirmed its earlier opinion. See G.M. Trading Corp. v. Commissioner, 106 T.C. 257, 1996 WL 182279 (1996) (G.M. Trading II).

II.

A.

We review the Tax Court's determinations of law de novo and its factual findings for clear error. See Bolding v. Commissioner, 117 F.3d 270, 273 (5th Cir. 1997). "A finding is `clearly erroneous' when although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed." United States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 542, 92 L.Ed. 746 (1948). Findings of fact influenced by an erroneous view of the law are entitled to no deference. See United States v. Capote-Capote, 946 F.2d 1100, 1102 (5th Cir.1991).

The Commissioner has promulgated Rev. Rul. 87-124, 1987-2 C.B. 205, to govern debt-equity swaps with foreign governments. According to this ruling, the taxpayer should pay gain on the value of the restricted foreign currency received minus the amount paid for the debt and any collateral expenses. The fair market value of the restricted foreign currency is determined "by taking into account all the facts and circumstances of the exchange."

This ruling implicitly holds that no portion of the debt-equity swap qualifies as a nontaxable contribution to capital. The Tax Court arguably followed this ruling, although it determined that the restrictions on the foreign currency did not lower its value. As we will explain, the Tax Court's ruling and Rev. Rul. 87-124 are erroneous as a matter of law.

B.

Section 118(a) of the Internal Revenue Code states, "In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer." 26 U.S.C. § 118(a). This exclusion is not limited to contributions by a shareholder; it "applies to the value of land or other property contributed to a corporation by a governmental unit or by a civic group for the purpose of inducing the corporation to locate its business in a particular community...." 26 C.F.R. § 1.118-1 (1996).

The test for determining whether a particular payment is a contribution to capital is "the intent or motive of the transferor." United States v. Chicago, Burlington & Quincy R.R., 412 U.S. 401, 411, 93 S.Ct. 2169, 2175, 37 L.Ed.2d 30 (1973); accord Deason v. Commissioner, 590 F.2d 1377, 1378 (5th Cir.1979). Specifically, the contribution (1) must become a part of the recipient's capital structure; (2) may not be compensation for a "specific, quantifiable service"; (3) must be bargained for; (4) must result in a benefit to the recipient; and (5) ordinarily will contribute to the production of additional income. Chicago, Burlington & Quincy R.R., 412 U.S. at 413, 93 S.Ct. at 2176.

The second prong is the only one contested by the Commissioner. Part of the payment by the Mexican government was in exchange for extinguishing a portion of Mexico's debt. This portion was compensation for a specific, quantifiable service and does not qualify as a nontaxable contribution to capital.

Another part of the payment was intended to induce G.M. to invest in the Mexican economy. This is not a specific, quantifiable service. A payment to induce investment is the quintessential nontaxable contribution to capital. See Brown Shoe Co. v. Commissioner, 339 U.S. 583, 591, 70 S.Ct. 820, 824, 94 L.Ed. 1081 (1950).

At first glance, the obvious solution is to bifurcate this payment into its constituent parts and tax G.M. on the value of the restricted pesos received in exchange for extinguishing the debt and exclude the balance from taxation. This solution, however, assumes that § 118(a) permits such bifurcation.

C.

1.

We are faced with three possible interpretations of § 118(a). G.M. argues that § 118(a) permits bifurcation. The Commissioner and the Tax Court, on the other hand, argue that it does not, albeit on different theories.

The Commissioner argues that the "dominant purpose" of the entire transaction governs. If inducement to invest is the dominant purpose, the entire payment, including portions paid for services, constitutes a nontaxable contribution to capital. If payment for services is the dominant purpose, the entire payment is taxable.

The Tax Court, on the other hand, adopted an extreme "taint" theory. It held that § 118(a) was inapplicable unless the "only benefit" received by the government was an indirect civil benefit. G.M....