Reynolds Metals Co. v. Comm'r of Internal Revenue, 24939–93.

CourtUnited States Tax Court
Citation105 T.C. No. 20,105 T.C. 304
Decision Date16 October 1995
Docket NumberNo. 24939–93.,24939–93.
PartiesREYNOLDS METALS COMPANY and Consolidated Subsidiaries, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.


Robert A. Warwick and Frederick H. Robinson, for petitioners.

Lindsey D. Stellwagen and Kristine A. Roth, for respondent.

In 1969, S, P's wholly owned subsidiary, issued debentures, convertible into shares of common stock of P. In 1987, S called the debentures for redemption, thereby prompting most debenture holders to convert their debentures into P's common stock. The converted debentures were subsequently redeemed by S for cash in an amount equal to the principal of the debentures with accrued interest. P and its consolidated subsidiaries claimed a capital loss deduction under sec. 165(f), I.R.C., in the amount by which the fair market value of P's stock issued in the exchange exceeded the principal of the exchanged debentures. Held, P is not entitled to a capital loss deduction. International Telephone & Telegraph v. Commissioner, 77 T.C. 60 (1981), supplemented by77 T.C. 1367,affd. per curiam704 F.2d 252 (2d Cir.1983), distinguished.



Respondent determined deficiencies in petitioners' 1987 and 1988 Federal income taxes in the amounts of $430,030 and $357,028, respectively. The sole issue remaining in dispute is whether petitioners are entitled to a capital loss deduction for 1987, under section 165(f),1 with respect to certain convertible debentures issued by a wholly owned subsidiary and convertible into the stock of the common parent corporation.

All the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference.

Petitioners are the Reynolds Metals Company and Consolidated Subsidiaries (the Reynolds Group). The common parent is Reynolds Metals Company (hereinafter referred to as Metals). Metals is a Delaware corporation with its principal place of business in Richmond, Virginia. Metals and its consolidated subsidiaries filed their corporate income tax return for the taxable year ended December 31, 1987, with the Internal Revenue Service at Memphis, Tennessee.

At all relevant times, Metals served global markets as a supplier and recycler of aluminum and other products. It is a vertically integrated producer of a wide variety of value-added aluminum products. In 1987, Metals and its affiliates were among the largest producers of aluminum and aluminum products in the world.

On May 16, 1968, the Board of Directors of Metals unanimously approved the draft forms of an Offering Prospectus, Indenture, and Underwriting Agreement proposed to be used in the foreign offering of $50 million of subordinated guaranteed convertible debentures due 1988, predicated upon the fact that Metals' financial advisers recommended that the offering be marketed as promptly as practicable. The Board further approved a plan to organize a wholly owned Delaware subsidiary to issue the debentures. The plan was outlined in a document, presented to each member of the Board, entitled “Memorandum To The Holders Of First Mortgage Bonds Of Reynolds Metals Company. The plan contemplated that Metals would contribute its 31–percent interest in the Canadian British Aluminum Company Limited (CBA), a Quebec corporation, to the newly formed subsidiary, and that the subsidiary would purchase 47–percent and 5–percent interests in CBA from The British Aluminum Company Limited (BA), and Tubes Canadian Holdings Limited (TCH), respectively, using the proceeds of the offering. The remaining 17–percent interest in CBA was to remain publicly held. Metals owned directly and indirectly a 48–percent interest in BA.

It was intended that the funds were to be raised abroad in a manner not adversely affecting the U.S. balance of payments in compliance with a program initiated by the U.S. government on January 1, 1968, and set forth in Direct Foreign Investment Regulations. See 33 Fed.Reg. 49 (Jan. 3, 1968). The plan also contemplated that the newly formed subsidiary would satisfy the 80–percent income from non-U.S. sources requirement of those regulations in order to exempt the interest on the debentures from the U.S. withholding tax on nonresident aliens or foreign corporations and provide estate tax benefits to such aliens. See Committee on Taxation of International Finance and Investment of New York State Bar Association, Tax Section, “Report on International Finance Subsidiaries,” 28 Tax L.Rev. 443, 444 (1973).

The memorandum presented to the Board contemplated that Metals would benefit from the outlined plan in the following manner:

1. BA will increase its capacity for the production of primary aluminum and alumina in the United Kingdom.

2. Reynolds Metals will increase its equity ownership in CBA from 31% to 83%.

3. By making the Debentures convertible into its Common Stock, Reynolds Metals is potentially enlarging its equity base and is providing for a wider international distribution of its Common Stock.

On May 27, 1968, Reynolds Metals European Capital Corporation (RMECC) was organized as a wholly-owned subsidiary of Metals. RMECC's authorized capital stock was 100,000 shares, having a par value of $1. Metals acquired 1,000 shares of the RMECC stock for $1,000, which constituted all of the issued and outstanding stock. The organization of RMECC was ratified and approved by the Board of Directors of Metals at a special meeting held June 4, 1968. The board further directed that authorized, but unissued, common stock of Metals be reserved for the conversion feature of the debentures to be issued by RMECC.

Since its organization, RMECC has joined in the filing of the Reynolds Group's consolidated Federal income tax return. As of July 17, 1968, RMECC did not own or lease any physical facilities or properties other than books and records. Also, each of RMECC's directors and officers was an officer or director of Metals and received no remuneration from RMECC.

At the time of RMECC's incorporation, CBA owned and operated an aluminum reduction plant located at Baie Comeau, Quebec, having the capacity to produce approximately 115,000 tons of primary aluminum annually. An aluminum reduction plant converts raw materials, principally alumina, into primary aluminum using an electrolytic process. As of December 31, 1968, CBA had authorized and issued 1,088,999 class A shares and 3,500,000 class B shares.

In connection with the organization of RMECC, Metals made a contribution to RMECC's capital of its 31–percent interest in CBA, represented by 271,329 class A shares and 1,162,000 class B Shares of CBA. At the time of transfer, the shares, which Metals had acquired in 1966, had a total value on the books of Metals of $32,975,000. Metals also intended that RMECC would acquire, and then hold, the stock of CBA held by BA and TCH.

Metals and RMECC together negotiated the CBA stock acquisition from BA. Initially, it had been contemplated that RMECC would either acquire the shares directly, or that Metals would acquire the shares and make a capital contribution of the shares to RMECC.

On August 15, 1968, RMECC purchased from BA its 47–percent interest in CBA, including 56,400 class A shares and 2,100,000 class B shares, for the Canadian dollar equivalent of US$39,194,618 (C$42,049,800 x 0.9321). In consideration of the sale of its CBA stock to RMECC, Metals agreed to several considerations in favor of BA, including to procure the full and prompt performance of RMECC, to aid BA in procuring CBA to enter into termination contracts with BA, and to acquire the rights and assume all the obligations of BA with respect to its long-term contracts with CBA for exchanging alumina for aluminum and for the purchase of aluminum.

RMECC purchased a 5–percent interest in CBA, represented by 6,392 class A shares and 238,000 class B shares, on December 27, 1968, from TCH.

As of December 31, 1968, RMECC owned 334,121 class A shares and 3,500,000 class B shares of CBA. These shares represented a 95.9–percent voting interest and an 83–percent interest by value.

As of December 31, 1968, RMECC had a capital surplus of $34,290,413.47 and retained earnings of $692,457.82.

In 1968, RMECC issued $50 million of 5–percent Subordinated Guaranteed Convertible Debentures Due 1988 (the debentures) in the European market. The debentures were bearer bonds in denominations of $1,000, with interest coupons attached. The debentures bore interest from June 1, 1968, which was payable semi-annually on June 1 and December 1 each year. They were dated June 1, 1968, and matured on June 1, 1988.

RMECC sold the debentures to underwriters Dillon, Read & Co., S.G. Warburg & Co., Ltd., and Reynolds & Co., who agreed not to sell, directly or indirectly, any of the debentures to any citizen, resident, partnership, corporation, or any other entity located in the United States or its territories or possessions.

The legend on the face of the debentures states:

The issuer of this Debenture has been formed or availed of for the principal purpose of obtaining funds (directly or indirectly) for foreign issuers or foreign obligors. Consequently, the United States Internal Revenue Service has ruled that United States persons (as that term is defined in Section 4920(a)(4) of the United States Internal Revenue Code of 1954) will be required to report and pay United States Interest Equalization Tax with respect to acquisition of this Debenture except where a specific statutory exemption is applicable. [Emphasis added.]

The debentures were issued under an indenture (the indenture) dated as of June 1, 1968, among RMECC as obligor, Metals as guarantor and Chemical Bank New York Trust Company as indenture trustee. The indenture governs the rights and obligations of RMECC, Metals, and Chemical Bank as between themselves and with respect to the holders of debentures. The indenture was never modified or revoked.

The indenture contains, in...

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