Container Corp. v. Comm'r of Internal Revenue

• Decision Date: 17 February 2010
• Docket Number: No. 3607–05.,3607–05.
• Citation: 134 T.C. 122,134 T.C. No. 5
• Parties: CONTAINER CORPORATION, Successor to Interest of Container Holdings Corporation, Successor to Interest of Vitro International Corporation, Petitioner v. COMMISSIONER of INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

134 T.C. 122
134 T.C. No. 5

CONTAINER CORPORATION, Successor to Interest of Container Holdings Corporation, Successor to Interest of Vitro International Corporation, Petitioner
v.
COMMISSIONER of INTERNAL REVENUE, Respondent.

No. 3607–05.

United States Tax Court.

Feb. 17, 2010.

[134 T.C. 122]

Vitro, a Mexican corporation, charged P—one of its U.S. subsidiaries—a fee to guarantee P's debts. R determined a deficiency for failure to withhold 30 percent of such fees as “fixed or determinable annual or periodical” income received from a U.S. source under section 881(a), I.R.C.

Held: The guaranty fees are analogous to payments for a service and therefore are not U.S. source income. Under

[134 T.C. 123]

sec. 1.861–4, Income Tax Regs., the source of the service is where the service is performed. Because the guaranty was provided from Mexico, fees for the guaranty are Mexican source income. Thus, P didn't need to withhold 30 percent of the guaranty fees under section 881(a), I.R.C.

Emily A. Parker, for petitioner.

Dennis M. Kelly, for respondent.

OPINION HOLMES, Judge:

The Code puts a 30–percent tax on “fixed or determinable annual or periodical” income received by foreign corporations from sources within the United States. Vitro, S.A. is a Mexican corporation that charged one of its U.S. subsidiaries a fee to guarantee the subsidiary's debt to U.S. lenders. The question presented in this case is whether that fee is from a source within the United States.

Background

In 1901, Vitro, S.A. started making glass bottles for the local beer makers of Monterrey, Mexico. Over the next century, Vitro became one of Mexico's most successful businesses, eventually becoming a holding company and the corporate parent of a large number of consolidated and unconsolidated subsidiaries. These subsidiaries manufacture and market a wide range of products, including just about everything made from glass. Vitro provides administrative and support services to its Mexican operating subsidiaries through a wholly owned management subsidiary, Vitro Corporativo, S.A. (Corporativo).

This case involves Vitro's glass containers division. The glass container business is driven by economies of scale—greater production equals greater profits. And, in the late 1980s, Vitro—already Mexico's largest manufacturer of glass containers—decided to expand to the United States. It chose to enter the market by acquisition, and its targets were two U.S. companies, Anchor Glass Container Corp. and Latchford Glass Co. Anchor was the second largest glass container producer in the United States and a publicly traded company. Latchford was a closely held regional glass container producer headquartered in California.

[134 T.C. 124]

Vitro did not have glassmaking plants of its own in the United States, but had inched into the market by organizing marketing and distribution subsidiaries. In December 1988, Vitro reorganized these subsidiaries, and formed Vitro International Corp. as their U.S. holding company.

Then, in May 1989, Vitro organized C Holdings Corp. to be an acquisition company. Vitro merged C Holdings into Container Holdings Corp. in April 1990. (We refer to them collectively as Container.) Container's purpose was to help Vitro gain control of Anchor and Latchford. As is common in takeovers, Container then formed a shell corporation to acquire Anchor's and Latchford's stock. The plan was that this shell—THR Corp.—would get the stock, and then merge with Anchor and Latchford to form one large operating subsidiary under Container.

With the targets in sight and its squadron of acquisition vehicles ready to roll, Vitro next had to arm itself with financing. But here Vitro ran into a problem common to Mexican companies in the late '80s—an inability to rely on Mexican financing due to the peso devaluations of 1982 and 1987 which had left even the Mexican government unfinanceable. This made Vitro unfinanceable, because Standard & Poor or Moody's will not give a borrower a higher credit rating than that of its sovereign. Vitro needed to look elsewhere. It turned to two U.S. investment banks—Lazard, Freres & Co. and Donaldson, Lufkin & Jenrette (DLJ)—for help in negotiating the financing and strategy of what Vitro expected would be a hostile takeover.

Vitro wanted ultimately to finance the acquisition using a combination of bank debt, equity, and high-yield (or, as unwilling corporate targets usually called them, junk) bonds. But before Vitro could get permanent financing, it needed bridge financing for the tender offer. (Bridge financing is short-term financing that aims to provide money for a transaction. It is meant to be repaid after a borrower closes the transaction and can access the capital markets for a mix of short- and long-term debt and equity financing.) DLJ committed up to $295 million in bridge financing to Vitro because DLJ expected that once THR merged into Anchor and Latchford it would be a creditworthy operating company. DLJ formed Anchor Bridge Partnership with The Equitable Companies (DLJ's corporate parent) and a syndicate of banks

[134 T.C. 125]

to make the bridge loan to THR. Lazard and DLJ also lined up the components of what they expected would be the permanent financing for the acquisitions: hundreds of millions of dollars in bank loans and debt securities.

The plan began well. In the summer of 1989, Vitro and Container started quietly buying Anchor stock on the open market. Vitro contributed its shares to Container. By the end of July 1989, Container held 10.1 percent of Anchor's 14 million outstanding shares. Vitro then made a tender offer for the rest in August 1989. Anchor initially resisted, but after testing the market for alternatives, surrendered.¹

The sale was set to close on November 2, 1989, but on October 10, 1989 the junk-bond market collapsed when, in a completely unrelated development, the management of United Airlines found it could not finance its leveraged buyout. Without a market for junk bonds, Vitro's bridge financing looked like it might turn into bridge-to-nowhere financing. What followed was one temporary solution after another.

Vitro first scrambled to find the money it needed to complete the tender offer:

• On October 29, 1989, a group of banks led by Security Pacific National Bank loaned THR $139 million. This SPNB 1989 tender offer loan was due in six months.

• On November 2, 1989, THR issued $155 million of senior subordinated floating rates notes (THR 1989 bridge note) to Anchor Bridge. The THR 1989 bridge note was due in one year.²

• On November 2, 1989, Container made a $128 million equity contribution to THR in cash and Anchor and Latchford stock in exchange for THR stock.

• On November 2, 1989, Container loaned $25 million to THR (THR 1989 bridge loan). Vitro loaned $25 million to Container to make the loan to THR. (Vitro 1989 bridge loan). Both loans were due in one year.

By the end of 1989, the deal looked like this:

Image 1 (6.88" X 5.59") Available for Offline Print

[134 T.C. 126]

After the tender offer closed, THR owned 99 percent of Anchor's stock. Anchor redeemed the rest for cash in May 1990, which made Anchor a wholly owned subsidiary of THR. Vitro expected to refinance the SPNB 1989 tender offer loan and the THR 1989 bridge note as soon as the junk-bond market stabilized.

Then more bad news shattered any hopes Vitro had of financing the deal through junk bonds: On February 13, 1990, Drexel Burnham Lambert filed for bankruptcy. Drexel had created the high-yield bond market, but the market's collapse took Drexel with it and spurred a shift from debt to equity in the financing of the takeovers.³

On May 2, 1990, the SPNB 1989 tender offer loan became due. Vitro needed more time. To buy some, Vitro refinanced Anchor's debt with a loan from the group of banks with SPNB as their agent. SPNB divided the $268 million debt into two loans (SPNB 1990 loans):

•

[134 T.C. 127]

A $208 million term loan to refinance existing Anchor debt, pay related fees and expenses, and provide working capital for Anchor.

• A $60 million revolving credit loan to provide working capital for Anchor and Latchford (SPNB 1990 revolving loan).

The SPNB 1990 loans matured on July 31, 1994, and came with two conditions:

• Vitro had to contribute $184 million to the capital of THR through Container to repay the SPNB 1989 tender offer loan, and repay a portion of principal due on the THR 1989 Bridge Note as well as the accrued interest.

• SPNB could restrict the amount of other debt allowed at Anchor and the amount of money that could be paid out of Anchor to THR.

These conditions affected the THR/Anchor merger. When THR issued the THR 1989 Bridge Note, it expected to refinance the note after the merger, but SPNB's restrictions would not allow it to move that debt to Anchor as part of any refinancing. As a result, DLJ and Vitro decided that they needed to make the indebtedness more marketable if they were going to refinance the THR 1989 Bridge Note without Anchor.

Vitro decided that moving the Note to a U.S. subsidiary outside the Container group would do this. It chose International because that company had enough cashflow from its operations to service at least part of the Note. DLJ requested that Vitro guarantee the debt as consideration for the restructuring. Vitro then restructured the Note through a series of transactions:

• On May 2, 1990, International issued $151 million of senior notes (International 1990 bridge note) to Anchor Bridge, with $30 million of principal due December 31, 1990, $26 million of principal due December 31, 1991, and the unpaid principal balance due May 1, 1992. International loaned the proceeds to THR. Vitro guaranteed the International 1990 bridge note.

• On May 2, 1990, THR issued a $151 million note (THR 1990 senior note) to International. THR used the proceeds to repay the balance of the THR 1989 Bridge note.⁴ The THR

[134 T.C. 128]

1990 senior note was a “pay-in-kind” ⁵ NOTE BECAUSE OF the spnb...