Riggs Nat'l Corp. & Subsidiaries v. Comm'r of Internal Revenue

• Decision Date: 10 December 1996
• Docket Number: No. 24368–89.,24368–89.
• Court: U.S. Tax Court
• Parties: RIGGS NATIONAL CORPORATION & Subsidiaries, (f.k.a. Riggs National Bank and Subsidiaries), Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

107 T.C. 301

107 T.C. No. 18

RIGGS NATIONAL CORPORATION & Subsidiaries, (f.k.a. Riggs National Bank and Subsidiaries), Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 24368–89.

United States Tax Court.

Dec. 10, 1996.

P regularly made and participated in loans to borrowers located in foreign countries, including Brazil. It was one of hundreds of banks that were involved in the restructuring of Brazil's foreign debt.

As required by Brazilian law, various non-tax-immune Brazilian borrowers paid Brazilian withholding tax on their net loan interest remittances to P during 1980 through 1986. Although the Brazilian Supreme Court had held that, under Article 19 of the Brazilian Constitution, tax-immune Brazilian governmental entities, like the Central Bank, were not liable to pay withholding tax on their net loan interest remittances to foreign lenders, beginning in 1984, the Central Bank purportedly paid withholding tax on its Brazilian restructuring debt interest remittances to P.

On its income tax returns for 1980 through 1986, P claimed a foreign tax credit under sec. 901, I.R.C., for the purported withholding tax payments made by the Central Bank and other Brazilian borrowers on their net loan interest remittances to P.

1. Held: The withholding tax paid by non-tax-immune Brazilian borrowers is potentially creditable to P but must be reduced, under sec. 4.901–2(f)(3)(ii), Temporary Income Tax Regs., 45 Fed.Reg. 75653 (Nov. 17, 1980), and sec. 1.901–2(e)(3)(ii), Income Tax Regs., by the pecuniary benefit the borrowers received from the Brazilian Government. Nissho Iwai Am. Corp. v. Commissioner, 89 T.C. 765 (1987); Norwest Corp. v. Commissioner, T.C.Memo. 1992–282, affd. 69 F.3d 1404 (8th Cir.1995); Continental Ill. Corp. v. Commissioner, T.C.Memo. 1988–318, affd. without published opinion sub nom. Citizens & S. Corp. & Subs. v. Commissioner, 919 F.2d 1492 (11th Cir.1990), affd. in part and revd. in part 998 F.2d 513 (7th Cir.1993), followed.

2. Held, further: P is not legally liable for Brazilian tax on the Brazilian restructuring debt interest remittances it received from the Central Bank. Under Brazilian law, P was not required to pay Brazilian tax, and neither it nor the Central Bank had a legal liability to pay the withholding tax. The purported Central Bank withholding tax payments are not creditable to P because these purported payments were noncompulsory amounts and not a tax to Brazil. Sec. 1.901–2(e)(1), (5), Income Tax Regs.

Joel V. Williamson, Washington, DC, Thomas C. Durham, Scott M. Stewart, Richard M. Timmel, Patricia Anne Flaming, Chicago, IL, and Kim Marie Boylan, Washington, DC, for petitioner.

Theodore J. Kletnick, Morton Grove, IL, William G. Merkle, Chicago, IL, Diane P. Thaler, New York City, Paul S. Manning, Washington, DC, Rajiv Madan, Mary Ann Amodeo, New York City, and Janice E. Lamartine, Chicago, IL, for respondent.

JACOBS, Judge:

Respondent determined deficiencies in the Federal income tax of petitioner Riggs National Corporation & Subsidiaries, formerly known as Riggs National Bank and Subsidiaries.

The dispute involves petitioner's entitlement to foreign tax credit under section 901 ¹ for Brazilian taxes withheld on interest income petitioner received, during the years 1980 through 1986, as a result of its loans to Brazilian borrowers. The primary issues for decision are as follows: (1) Whether petitioner is legally liable for the Brazilian withholding tax purportedly paid by its Brazilian borrowers on their net loan interest remittances to petitioner (the legal liability issue); (2) whether the alleged withholding tax paid by the Banco do Central Brazil (Central Bank) on its Brazilian restructuring debt interest remittances to petitioner is a noncompulsory amount and thus not a tax to Brazil (the Central Bank issue); and (3) whether a subsidy, equal to a percentage of the tax withheld, that borrowers received from the Brazilian Government during the period from January 1, 1980, through June 28, 1985, reduces the amount of foreign tax credit allowable to petitioner (the subsidy/pecuniary benefit issue).

To a major extent, the legal liability and subsidy/pecuniary benefit issues have been previously dealt with in Norwest Corp. v. Commissioner, T.C.Memo. 1992–282, affd. 69 F.3d 1404 (8th Cir.1995); First Chicago Corp. v. Commissioner, T.C.Memo. 1991–44; Continental Ill. Corp. v. Commissioner, T.C.Memo. 1988–318, affd. without published opinion sub nom. Citizens & S. Corp. & Subs. v. Commissioner, 919 F.2d 1492 (11th Cir.1990), affd. in part and revd. in part 998 F.2d 513 (7th Cir.1993) and Nissho Iwai Am. Corp. v. Commissioner, 89 T.C. 765 (1987). However, none of those cases involved withholding tax paid by a tax-immune Brazilian governmental entity/borrower, like the Central Bank here, on its Brazilian restructuring debt interest remittances.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly. The parties have further stipulated in evidence portions of the trial transcripts in the Continental Illinois and Nissho Iwai cases and various exhibits related to the testimony of certain witnesses in those cases.

A. Background

Petitioner's principal place of business was in Washington, D.C., at the time the petition was filed.

Riggs National Corporation is the parent company of a group of corporations which filed consolidated income tax returns for the years in issue. Its wholly owned subsidiary Riggs National Bank regularly made and participated in loans to borrowers located in foreign countries, including Brazil.

B. Foreign Loans and the Brazilian Economy in General

In 1974, Brazil incurred a trade deficit of $4.7 billion as a result of higher prices charged for oil due to the energy crisis. At that time, a trade deficit of this size was large for Brazil. After 1974, Brazil greatly increased its reliance on foreign debt. Its foreign debt increased dramatically from 1974 to 1983, and the ratio of Brazil's total foreign debt to its foreign currency reserves grew larger. The Brazilian Government sought to reduce Brazil's trade deficit by decreasing imports, increasing exports, and encouraging foreign borrowing for internal domestic development. It hoped to increase the country's productive capacity by stimulating greater investment in steel, oil, pulp and paper, aluminum, petrochemical products, fertilizers, capital goods, and other capital items.

Brazil's currency, the cruzeiro, was not convertible to foreign currency in international markets. Although the cruzeiro was freely tradeable, as a practical matter, foreign parties outside of Brazil would not accept payment in cruzeiros.

Brazil needed to maintain adequate foreign currency reserves to engage in international trade to finance its trade deficit. During 1974 through 1975, the Brazilian Government sought to maintain a foreign currency reserve of about $6 billion for this purpose.

During 1974, Brazilian borrowers generally were reluctant to take out foreign loans because the Central Bank required a minimum term for foreign loans which varied from 5 to 12 years. Although the Brazilian Government sought to decrease the effects of inflation through an indexing system, in taking out a long-term foreign loan, a Brazilian borrower incurred a substantial risk that a decline in the exchange rate for the cruzeiro as a result of domestic inflation could increase the cost of the loan.

To increase foreign borrowing, the Brazilian Government provided incentives to Brazilian borrowers in order to overcome their reluctance to take out foreign loans. These incentives included the pecuniary benefit, the Resolution 63 loan program, and the Resolution 432 loan program, all of which are more fully discussed infra.

Until about 1982, lending to Brazilian borrowers was quite profitable for many foreign lenders, including some major U.S. banks. The interest rate spreads (i.e., the interest rate charged on a loan, less the cost of the loan funds to the lender) on Brazilian loans were higher than the interest rate spreads on loans made in many other countries. In addition, the ability to claim foreign tax credits significantly enhanced the after-tax income some foreign lenders derived with respect to their Brazilian loans.

C. Brazilian Regulation of Foreign Lending

Brazil imposes restrictions on the receipt and exchange of foreign currency. By law, all loans from foreign lenders to Brazilian borrowers must be registered with and approved by the Central Bank. Through the registration process, the Central Bank sets the range of acceptable interest rates and periodically establishes the minimum repayment terms of loans. Once the Central Bank approved a loan, the lender remitted the proceeds in foreign currency to the borrower via a commercial bank in Brazil. The Brazilian bank converted the foreign currency into Brazilian currency by means of an exchange contract, whereby the borrower sold the foreign currency to the bank for Brazilian currency at the official exchange rate periodically set by the Central Bank.

The Brazilian borrower received a Certificate of Registration that enabled the borrower to effect payment of interest and principal in the foreign currency in which the loan was made. On each payment date, the borrower purchased foreign currency from a Brazilian bank at the official exchange rate. The Brazilian bank then tendered the foreign currency to the foreign lender.

D. Payment of the Withholding Tax Generally

Where withholding tax is required, Brazilian law prohibited remittance of an interest payment to a foreign lender without proof of payment of the withholding tax on interest remitted abroad. Under Brazilian law, the borrower initiated payment of the withholding tax by submitting a Documento de Arrecadacao de Receitas Federais (DARF) and the accompanying tax payment to a commercial Brazilian bank. Any bank making an interest payment in foreign currency which was subject to Brazilian...