G.M. Trading Corp. v. Comm'r of Internal Revenue

• Citation: 106 T.C. 257,106 T.C. No. 13
• Decision Date: 17 April 1996
• Docket Number: No. 6983-91.,6983-91.
• Parties: G.M. TRADING CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.*
• Court: United States Tax Court

106 T.C. 257

106 T.C. No. 13

G.M. TRADING CORPORATION, Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.*

No. 6983-91.

United States Tax Court.

April 17, 1996.

R. James Curphy, San Antonia, TX, for petitioner.^**

T. Richard Sealy III, Austin, TX, for respondent.

On reconsideration, we decline to alter any of the findings of fact or conclusions of law set forth in our prior opinion at 103 T.C. 59 (1994). Supplemental findings of fact and conclusions of law made.

Held, we adhere to our prior holding that petitioner is to be treated as having realized a taxable gain on the exchange of U.S. dollar-denominated Mexican Government debt for Mexican pesos. We also adhere to our prior findings and conclusions regarding the value of the pesos received and the amount of gain realized.

SUPPLEMENTAL OPINION

SWIFT, Judge:

This matter is before us on reconsideration of our opinion at 103 T.C. 59 (1994), in which we concluded that petitioner realized a taxable gain in connection with a “Mexican debt-equity-swap” transaction. On October 13, 1994, we granted petitioner's motion for reconsideration, and we requested that petitioner and respondent file briefs on the points raised in petitioner's motion for reconsideration. We also allowed amici briefs to be filed by Chrysler Corp. and by Harold L. Adrion.

On reconsideration, petitioners and the amici curiae make three primary arguments: (1) That the value of the Mexican pesos that were received by petitioner (or by Procesos, petitioner's Mexican subsidiary corporation) did not exceed petitioner's U.S. dollar cost of participating in the transaction and that petitioner, therefore, realized no gain on the transaction; (2) that the transaction should not be viewed as a taxable exchange because petitioner could not legally own an interest in the U.S. dollar-denominated debt of the Mexican Government; and (3) that if gain was realized over petitioner's cost of participating in the transaction, such gain should be regarded, under section 118, as a nontaxable capital contribution by the Mexican Government to petitioner or to Procesos.

We have considered the arguments and voluminous material submitted by petitioner, by the amici curiae, and by respondent. We, however, remain convinced as to the correctness of our prior findings and opinion. Accordingly, we decline to alter any of the findings of fact or conclusions of law set forth in our prior opinion.

Our prior opinion explained the general nature of the Mexican debt-equity-swap transaction that is at issue in this case, and we will not repeat that explanation. We, however, do make herein a number of supplemental findings of fact and conclusions of law, and we provide additional explanation for our opinion, as set forth below.

For convenience, we combine our supplemental findings of fact and conclusions of law.

All section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

Value of Mexican Pesos

It is argued by petitioner and by the amici curiae that the fair market value of the Mexican pesos that petitioner or Procesos, as petitioner's designee, received to construct and to operate a lambskin processing plant in Mexico should be presumed to be equal to or measured by petitioner's US $634,000 cost of participating in the transaction. We disagree. We continue to believe that the fair market value of the Mexican pesos should be governed by the fair market US$/Mex$ exchange rate that existed on November 5, 1987.

In order to participate in this transaction and to receive Mex $1,736,694,000 to invest in Mexico, petitioner incurred not only a hard currency cost of US$634,000, but petitioner also --

(1) agreed to transfer to the Mexican Government for cancellation the US $1,200,000-denominated debt that petitioner purchased from the NMB Nederlandsche Middenstandsbank N.V. Bank (NMB Bank);

(2) agreed to invest in Mexico all of the Mexican pesos that were received; and

(3) agreed to provide jobs for Mexican nationals at the lambskin processing plant to be constructed in Mexico.

Even though these three additional elements did not have an immediate hard currency cost to petitioner and did not increase petitioner's tax basis or tax cost in the transaction, such additional elements provided by petitioner to the Mexican Government represented valuable and material aspects of the transaction and should not be ignored if we are to properly value the currency consideration received by petitioner (namely, the Mex$1,736,694,000). Petitioner's argument (and that of the amici curiae) that the Mexican pesos are presumed equal to petitioner's US$634,000 currency cost of participating in this transaction ignores the value of these significant additional elements provided by petitioner.

Petitioner's purchase of the US$1,200,000 Mexican Government debt and petitioner's transfer of this debt to the Mexican Government for cancellation, without the Mexican Government spending any U.S. dollars, constituted a primary purpose of this transaction. If the financial interests of the Mexican Government would have been just as well-served (as the amici curiae apparently contend) by the Mexican Government itself purchasing for US$600,000 the US $1,200,000 Mexican Government debt and then canceling that debt, perhaps the transaction could have been so structured.

To the contrary, however, the transaction was structured so that the US $1,200,000 Mexican Government debt would be canceled without the Mexican Government using any of its limited supply of U.S. dollars and also without any of the Mexican pesos that were used in the transaction leaving Mexico. From the standpoint of both petitioner and the Mexican Government, these two features or benefits of the transaction, made possible by the additional elements provided by petitioner as described above, shape the form and substance of the transaction before us.

We therefore believe that it would be artificial to presume, as petitioner and the amici curiae would have us do, that the value of the Mex$1,736,694,000 (the currency consideration received by petitioner or by Procesos, as petitioner's designee, for participating in this transaction) equals petitioner's US$634,000 cost of purchasing the US$1,200,000 Mexican Government debt and transferring the debt to the Mexican Government. This argument ignores that in reality the Mexican Government acquired from petitioner not only the surrender of the debt, but also the additional three elements identified above.

Respondent, in her brief, accurately describes petitioner's taxable gain from engaging in this transaction as follows:

In a traditional, private market transaction, for US$600,000 petitioner would have obtained no more than Mex$998,100,000 based on the free-market exchange peso/dollar exchange rate at the time [of] the Debt/Equity Swap * * * which would have allowed it to have acquired land and build a plant worth only US $600,000. Instead, using the Debt/Equity Swap, * * * [petitioner] obtained Mex $1,736,694,000 for the same amount of money, allowing it to build a plant worth US$1,044,000. The increase obtained as a result of the swap was Mex $738,594,000 (Mex$1,736,694,000 less Mex$998,100,000) which, on the date of the Debt/Equity Swap, was equal in value to US$444,000 (Mex$738,594,000 divided by 1,663.50 (pesos/dollar free-market exchange rate on date of swap)), which is precisely the amount of gain which respondent contends petitioner realized on the transaction (fair market value of Mex$1,736,694,000 received in exchange for the US$1,200,000 Face Amount Mexican Debt (US$1,044,000) less amount paid for the debt (US$600,000)), less US$34,000 of transaction costs.

More broadly, if the “restricted pesos” which petitioner obtained were worth no more than the US$600,000 which * * * [petitioner] paid for the debt, why then did * * * [petitioner] even go to the trouble of participating in the Debt/Equity Swap? Completing the swap involved a good deal of time and expense for petitioner--a detailed application had to be submitted, negotiations with relevant Mexican Government agencies had to be conducted, and approvals had to be obtained. If what was received as a result of the swap was no more valuable than what could have been obtained outside of it, why was it done? The answer is obvious--petitioner went to the trouble of participating in the swap because of the added value which it obtained through so doing. * * * This added value * * * [constitutes] a realized gain for federal income tax purposes, and no provision of the internal revenue laws exempts it from recognition. [[[Emphasis added.]

Respondent's above explanation is consistent with the following summary of the “basics” of debt-equity-swap transactions, viewed from the U.S. taxpayer's perspective, as set forth in an attachment to the brief of Chrysler, as amicus curiae:

At its simplest, a debt-equity swap (also known as a debt conversion) involves the purchase by a firm, usually foreign, of sovereign debt at a discount in the secondary market from the bank holding it. The issuing country then buys back the debt in local currency at close to its face value. The firm spends the local currency received in an approved manner within the country, usually to finance a fixed equity investment. Since the prepayment of the obligation is made at a substantial discount and the local funds are obtained at a much smaller discount, firms can realize a significant gain on the spread. [Business International Corp., Debt-Equity Swaps: How To Tap an Emerging Market (1987). Emphasis added.]

With regard to the value of the Mex$1,736,694,000 that was received, petitioner and the amici curiae argue strenuously that the Court in our prior opinion improperly considered subjective factors to minimize the effect of certain restrictions on the use of the Mexican pesos and that such subjective factors are...