Lohler Co. v. U.S.
| Decision Date | 20 February 2003 |
| Docket Number | No. Ol-C-753.,Ol-C-753. |
| Citation | 247 F.Supp.2d 1083 |
| Parties | KOHLER COMPANY, Plaintiff, v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — Eastern District of Wisconsin |
Herbert Odell, Troy Olsen, Miller & Chevalier, Bala Cynwyd, PA, Janice A Rhodes, Stephen E. Kravit, Kravit Gass Hovel & Leitner, Milwaukee, WI, Philip Karter, Miller & Chevalier, Bala Cynwyd, PA, for Plaintiff.
Charles P Hurley, Richard R. Ward, Steven D. Silverman, United States Department of Justice (DC), Tax Division, Washington, DC, James L Santelle, United
States Department of Justice (ED-WI), Office of the U.S. Attorney, Milwaukee, WI, for Defendant.
DECISION AND ORDER
In a four-party transaction, plaintiff Kohler Company purchased an interest in U.S. dollar denominated debt obligations of the Mexican government from an unrelated seller, a U.S. bank. Kohler then exchanged its interest in the debt obligations for equity in a newly formed Mexican subsidiary which was funded, upon cancellation of the debt, by a deposit of Mexican pesos in a restricted account for the benefit of the subsidiary by the Mexican government. The dollar value of the pesos deposited in the account exceeded the dollar amount that Kohler had paid for its interest in the debt obligations.
The defendant United States conducted an audit of the transaction. It concluded that Kohler realized a short-term capital gain of $8,386,296, the difference between what Kohler had paid for the Mexican debt obligation and the dollar value of the face amount of restricted pesos made available to its subsidiary, and assessed the tax it claimed was due. Kohler paid the tax assessed under protest and commenced this action. Kohler now seeks a refund, contending alternatively that the value of the restricted peso credits equaled the amount paid for the obligations, that any excess was a non-taxable contribution to capital by Mexico, or that any gain realized is not recognized under the 26 U.S.C. § 367. Because Kohler believes its arguments succeed as a matter of law, it has filed a motion for summary judgment.
The United States contends that Kohler realized a substantial gain equal to the difference between the amount it paid for the interest in the Mexican debt obligations it acquired and the face value of the peso credits made available to its subsidiary, and that the tax assessed on this gain was proper. Alternatively, the United States contends that, in the event I conclude that the fair market value of the restricted account made available to Kohler's subsidiary is less than the dollar value the peso credits granted by Mexico, a factual dispute exists as to what Kohler's actual gain may be, and it should be allowed an opportunity to conduct further discovery on that issue. In either event, the United States contends that Kohler's motion should be denied.
For the reasons set forth below, I find that there are material facts in dispute and thus Kohler is not entitled to judgment as a matter of law. I therefore deny Kohler's motion for summary judgment. And because Kohler's motion for summary judgment is denied, the government's motion for leave to conduct further discovery will be denied as moot.
Plaintiff Kohler Company is a United States corporation with its principal place of business in Kohler, Wisconsin. Among its varied businesses, Kohler manufactures plumbing products that are marketed and sold around the world. In 1987, Kohler decided to build a plant, to be owned and operated by its subsidiary, Sanimex1, in the Monterrey, Nuevo Leon, Mexico, for the manufacturing of vitreous china plumbing products for export. Significantly lower labor costs were the driving force behind locating the plant outside the United States. Further, Kohler wanted to increase its production capacity for lower cost plumbing products in a location within a geographically efficient proximity to the United States, the intended market for such products.
In the course of arranging for the financing of the construction of its new facility, Kohler became aware of the Mexican debt equity swap program. This program was developed during the 1980's, when Mexico was experiencing an economic crisis due, in large part, to a decline in the value of its oil reserves. Because of the economic crisis, Mexico was having difficulties paying its foreign-currency-denominated debt. The "debt equity swap" program was created to reduce the outstanding balance of the Mexican government's foreign-currency-denominated debt and to encourage foreign investment in Mexico.
Negotiated between the government of Mexico and other Mexican public sector debtors and the many foreign lending banks holding imperiled debt obligations, the debt equity swap program was established by the Mexican government pursuant to section 5.11 of the Agreement on the Restructure of the Foreign Public Debt (the "Restructure Agreement") dated August 29, 1985. For the foreign lending banks holding Mexican debt, the debt equity swap program, coupled with the liberalization of Mexico's foreign investment laws, helped generate a market among United States companies and others for the acquisition of such debt.
Under the debt equity swap program, non-Mexican corporations were allowed to create and/or fund subsidiary operations in Mexico using pesos supplied by the Mexican government if the non-Mexican corporation agreed to purchase an interest in a discounted debt obligation from one of Mexico's creditor banks. The debt equity swap program was designed to ensure that the debt would be canceled without requiring Mexico to use foreign currency, that payments made in exchange for the debt cancellation would remain in Mexico, and that foreign currency would enter the country through the export of goods manufactured by the Mexican subsidiary of the non-Mexican corporation, thus improving Mexico's account of foreign currency reserves.
The program required participating corporations to dedicate production for foreign markets and to construct their facilities using only Mexican labor and materials. The Mexican government considered the debt equity swap program to have positive effects on employment and on Mexico's balance of payments. In determining how much it would pay for the debt obligations under the debt equity swap program, Mexico employed a sliding scale. Those projects that met certain characteristics were favored over projects that did not. The most favored projects employed new technology and had one or more of the following characteristics: new production intended for export; purchase of a Mexican company with 100 percent foreign capital; and production preventing outflow of foreign exchange or generating foreign exchange. The least-favored projects under the debt equity swap generated no foreign exchange.
Under the Restructure Agreement between Mexico and its creditors, any bank that obtained a proportionately greater payment on Mexican obligations than other banks was required to share the excess ratably with all other banks by purchasing interests in Mexican debt from the other banks. Swap transactions were specifically excluded from this requirement.
Kohler recognized the debt equity swap program as an opportunity to realize even greater savings on its planned investment in Mexico. After deciding to apply for participation in the debt equity swap program Kohler approached several banks to explore the market for the acquisition of interests in Mexican debt. At the time Kohler was considering participation in the debt equity swap program, the Mexican debt interests being offered by the various banks were at approximately fifty cents on the dollar. The discount in the face value of the Mexican debt obligations offered by the banks reflected the fair market value of Mexican debt interests at the time.
On May 15, 1987, Kohler applied for approval to participate in the debt equity swap program established by the Mexican government pursuant to section 5.11 of the Restructure Agreement. Kohler's application was made pursuant to the provisions of the Operating Manual for the Capitalization of Liabilities and the Replacement of Public Debt with Investment (the "Operating Manual"). The Operating Manual was published jointly by the Ministry of Finance and Public Credit and the National Commission on Foreign Investment, both agencies of the Mexican government. The Operating Manual set forth general and specific procedures for section 5.11 transactions during the period at issue.
By letter dated September 4, 1987, the National Commission on Foreign Investment, on behalf of the Mexican government, approved Kohler's application. By letter dated September 14, 1987, the Ministry of Finance and Public Credit approved Kohler's application.
On October 16, October 23, and December 28, 1987, Kohler purchased from Bankers Trust Company an interest in debt obligations of the Mexican government, which obligations were traded on the public market. The principal balance of the debt interest so acquired was $22,439,000 in United States dollars. Kohler acquired these debt obligations for $11,114,267 in United States dollars. Kohler's transaction with Bankers Trust to acquire these debt obligations was an arms-length transaction between unrelated parties, and the price paid was the fair market value of these debt obligations at the time. For Bankers Trust, the amount it received represented the best price at which these debt obligations could be sold.
On December 23, 1987, Kohler and Bankers Trust entered into an Assignment Agreement, which set forth the terms of the assignment by Bankers Trust to Kohler of the interest in these debt obligations for the sum of $11,114,267 in United States dollars. Meanwhile, on December 15, 1987, Kohler, Sanimex, Bankers Trust, and the Mexican government entered into a Conversion Agreement setting forth the manner in which the debt equity swap transaction was to be consummated.
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