G.M. Trading Corp. v. Commissioner , 121 F.3d 977 ( 1997 )

REVISED
United States Court of Appeals,
Fifth Circuit.
No. 96-60679.
G.M. TRADING CORPORATION, Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
Sept. 12, 1997.
Appeal from the Decision of the United States Tax Court.
Before JOLLY, SMITH and DENNIS, Circuit Judges.
JERRY E. SMITH, Circuit Judge:
G.M. Trading Corporation ("G.M.") surrendered $600,000 worth
of Mexican national debt to the Mexican government and received
approximately 1.7 billion pesos restricted to the construction of
a plant in Mexico. The Tax Court found that G.M. recognized
$410,000 of gain. Concluding, to the contrary, that the pesos
received in exchange for the debt extinguishment were worth
$600,000, and the balance of the value received constituted a
nontaxable contribution to capital, we reverse and render judgment
for the taxpayer.
I.
A.
In the late 1980's, the Mexican government maintained a policy
designed to encourage foreign investment and to decrease the
outstanding balance of its foreign-currency-denominated debt (the
"Program"). The Program had many different incarnations; we need
consider only one.
Under "Mecanismo No. 4," a foreign corporation would purchase
foreign-currency denominated debt from a bank and surrender that
debt to the Mexican government. For its part, the Mexican
government would grant a certain number of pesos to a new Mexican
subsidiary of the foreign corporation. Usually, these pesos would
be restricted to uses benefiting the Mexican economy. The stock
that the foreign corporation received would be subject to
restrictions on transfer and dividends.
The number of pesos granted was determined by a set formula.
Mexico paid the face amount of the debt retired, discounted by 0%
to 25%. Because Mexico was not making interest or principal
payments at the time, the market discount on the debt always was
higher than 25%.
The particular amount of the discount was calculated "upon the
perceived benefit of each proposed investment to the Mexican
economy." Specifically, the Mexican government desired to
encourage foreign investment, high-technology businesses, and high
export production. A 100% foreign investor forming a
high-technology business exporting at least 80% of its production
would receive a 5% discount.
B.
G.M.1 is a Texas corporation engaged in the processing of
sheep skins. In 1987, G.M. was interested in locating a plant in
Acuña, México, and contacted the Mexican government about
participating in the Program. The Mexican government approved
1
"G.M." stands for General Merchandise. It not related to
General Motors Corporation.
G.M.'s proposal and, in November 1987, the following transaction
(the "Transaction") occurred:
1) For $600,000, G.M. purchased U.S.-dollar-denominated
Mexican debt bearing a face value of $1,200,000 from a Dutch bank.
The fair market value of this debt at the time was $600,000. G.M.
also incurred fees and costs totaling $34,000.
2) G.M. caused that debt to be surrendered to the Mexican
government.
3) The Mexican government tendered to Procesos G.M. de México,
S.A. de C.V. ("Procesos"), a subsidiary of G.M., 1,736,694,000
pesos restricted to the construction of a sheep skin processing
plant in Acuña. The amount of 1,736,694,000 unrestricted pesos
would have had a fair market value of $1,044,000.2
These pesos were highly restricted. They could be used only
2
G.M. urges that we apply the step transaction doctrine and
recharacterize the Transaction. Specifically, G.M. urges that we
treat G.M. as having contributed $600,000 to Procesos and Procesos
having purchased the restricted pesos from the Mexican government.
We must reject this suggestion.
The step transaction doctrine allows the disregard of
steps that have no substance. See Esmark, Inc. v.
Commissioner, 90 T.C. 171, 195, 1988 WL 5887 (1988) (stating
that the doctrine mandates ignoring "meaningless or
unnecessary steps"), aff'd mem., 886 F.2d 1318 (7th Cir.1989)
(table). It does not allow the invention of steps that did
not happen. See Grove v. Commissioner, 490 F.2d 241, 247-48
(2d Cir.1973) (quoting Sheppard v. United States, 176 Ct. Cl.
244, 361 F.2d 972, 978 (1966) (per curiam)); Esmark, 90 T.C.
at 196 ("This recharacterization does not simply combine
steps; it invents new ones. Courts have refused to apply the
step-transaction doctrine in this manner.").
The record unambiguously shows that G.M. paid $600,000 to
the bank, and Procesos never had possession of that money. It
is ironic that G.M. argues that the substance of the
Transaction was that Procesos made an exchange with the
Mexican government, when Procesos would not have existed
absent the transaction.
for the purchase of land and the construction and outfitting of an
industrial plant in Acuña. The Mexican government controlled the
pesos and paid them to vendors directly.
The identity of those vendors also was restricted greatly.
For example, Procesos had to employ Mexican companies and use
Mexican goods and services in constructing the plant. Procesos
could purchase land only from persons willing to reinvest the sale
proceeds in México. Until use, the pesos bore interest at the rate
for treasury certificates. The interest, unlike the principal, was
not restricted.
G.M.'s stock in Procesos was subject to additional
restrictions. G.M. could not transfer the stock to a non-Mexican
entity until 1998. The stock could not be redeemed on a basis more
favorable than the amortization of the debt surrendered. With a
minor exception, the stock could not pay guaranteed dividends
"irrespective of earnings and profits." Finally, the stock could
not be converted into stock that did not contain these
restrictions.
C.
G.M. reported no taxable gain on the Transaction. The
Commissioner of Internal Revenue (the "Commissioner") determined
that G.M. recognized a gain of $601,7453 and issued a notice of
deficiency for that amount. G.M. petitioned the Tax Court for a
redetermination.
3
The Commissioner determined that G.M. realized $1,200,000
from the Transaction, paid $540,000, and incurred costs of $58,255.
It is difficult to understand how the Commissioner arrived at these
numbers.
Before the court, the Commissioner argued that G.M.'s gain was
$1,044,000 minus $634,000, or $410,000. G.M. continued to argue
that it had no taxable gain. The Tax Court adopted the
Commissioner's position. See G.M. Trading Corp. v. Commissioner,
103 T.C. 59, 1994 WL 386151 (1994). The court granted rehearing
and then affirmed its earlier opinion. See G.M. Trading Corp. v.
Commissioner, 106 T.C. 257, 1996 WL 182279 (1996) (G.M. Trading II
).
II.
A.
We review the Tax Court's determinations of law de novo and
its factual findings for clear error. See Bolding v. Commissioner,
117 F.3d 270, 273 (5th Cir.1997). "A finding is "clearly
erroneous' when although there is evidence to support it, the
reviewing court on the entire evidence is left with the definite
and firm conviction that a mistake has been committed." United
States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S. Ct.
525, 542, 92 L. Ed. 746 (1948). Findings of fact influenced by an
erroneous view of the law are entitled to no deference. See United
States v. Capote-Capote, 946 F.2d 1100, 1102 (5th Cir.1991).
The Commissioner has promulgated Rev. Rul. 87-124, 1987-2 C.B.
205, to govern debt-equity swaps with foreign governments.
According to this ruling, the taxpayer should pay gain on the value
of the restricted foreign currency received minus the amount paid
for the debt and any collateral expenses. The fair market value of
the restricted foreign currency is determined "by taking into
account all the facts and circumstances of the exchange."
This ruling implicitly holds that no portion of the
debt-equity swap qualifies as a nontaxable contribution to capital.
The Tax Court arguably followed this ruling, although it determined
that the restrictions on the foreign currency did not lower its
value. As we will explain, the Tax Court's ruling and Rev. Rul.
87-124 are erroneous as a matter of law.
B.
Section 118(a) of the Internal Revenue Code states, "In the
case of a corporation, gross income does not include any
contribution to the capital of the taxpayer." 26 U.S.C. § 118(a).
This exclusion is not limited to contributions by a shareholder;
it "applies to the value of land or other property contributed to
a corporation by a governmental unit or by a civic group for the
purpose of inducing the corporation to locate its business in a
particular community...." 26 C.F.R. § 1.118-1 (1996).
The test for determining whether a particular payment is a
contribution to capital is "the intent or motive of the
transferor." United States v. Chicago, Burlington & Quincy R.R.,
412 U.S. 401, 411, 93 S. Ct. 2169, 2175, 37 L. Ed. 2d 30 (1973);
accord Deason v. Commissioner, 590 F.2d 1377, 1378 (5th Cir.1979).
Specifically, the contribution (1) must become a part of the
recipient's capital structure; (2) may not be compensation for a
"specific, quantifiable service"; (3) must be bargained for; (4)
must result in a benefit to the recipient; and (5) ordinarily will
contribute to the production of additional income. Chicago,
Burlington & Quincy R.R., 412 U.S. at 413, 93 S.Ct. at 2176.
The second prong is the only one contested by the
Commissioner. Part of the payment by the Mexican government was in
exchange for extinguishing a portion of Mexico's debt. This
portion was compensation for a specific, quantifiable service and
does not qualify as a nontaxable contribution to capital.
Another part of the payment was intended to induce G.M. to
invest in the Mexican economy. This is not a specific,
quantifiable service. A payment to induce investment is the
quintessential nontaxable contribution to capital. See Brown Shoe
Co. v. Commissioner, 339 U.S. 583, 591, 70 S. Ct. 820, 824, 94 L. Ed.
1081 (1950).
At first glance, the obvious solution is to bifurcate this
payment into its constituent parts and tax G.M. on the value of the
restricted pesos received in exchange for extinguishing the debt
and exclude the balance from taxation. This solution, however,
assumes that § 118(a) permits such bifurcation.
C.
1.
We are faced with three possible interpretations of § 118(a).
G.M. argues that § 118(a) permits bifurcation. The Commissioner
and the Tax Court, on the other hand, argue that it does not,
albeit on different theories.
The Commissioner argues that the "dominant purpose" of the
entire transaction governs. If inducement to invest is the
dominant purpose, the entire payment, including portions paid for
services, constitutes a nontaxable contribution to capital. If
payment for services is the dominant purpose, the entire payment is
taxable.
The Tax Court, on the other hand, adopted an extreme "taint"
theory. It held that § 118(a) was inapplicable unless the "only
benefit" received by the government was an indirect civil benefit.
G.M. Trading II, 106 T.C. 266 (quoting Federated Dep't Stores,
Inc. v. Commissioner, 51 T.C. 500, 519, 1968 WL 1414 (1968), aff'd,
426 F.2d 417 (6th Cir.1970)). In other words, the Tax Court held
that any amount of direct services taints the entire transaction
and makes § 118(a) inapplicable.
2.
As always, we begin our investigation by examining the plain
language of the statute. See Ojo v. INS, 106 F.3d 680, 681 (5th
Cir.1997). Absent indications to the contrary, we assume that the
words in a statute carry their ordinary meaning. See Pioneer Inv.
Servs. Co. v. Brunswick Assocs. Ltd. Partnership, 507 U.S. 380,
388, 113 S. Ct. 1489, 1494-95, 123 L. Ed. 2d 74 (1993). Where
possible, every word in a statute should be given meaning. See
Nalle v. Commissioner, 997 F.2d 1134, 1139 (5th Cir.1993). Section
118(a) states that "gross income does not include any contribution
to the capital of the taxpayer."
We find the use of the word "any" to be significant. See
Rekant v. Desser, 425 F.2d 872, 880 n. 15 (5th Cir.1970) (relying
on the broad scope of the plain meaning of "any"). According to
the plain terms of the statute, anything that qualifies as a
contribution to capital is nontaxable. The statute mandates
bifurcation by requiring that any, rather than some, contributions
to capital be excluded from income.
The statute does not direct us to look at a multi-part payment
as a whole. Both the Commissioner's and the Tax Court's theories
require us to do so. As a result, both theories require the
imposition of taxation on contributions to capital. That is
plainly inconsistent with the statute.
3.
a.
This interpretation of § 118(a) is well supported by
precedent. In Concord Village, Inc. v. Commissioner, 65 T.C. 142,
1975 WL 3188 (1975), for example, the Tax Court bifurcated monthly
carrying fees paid by tenants to a cooperative. The court held
that the portion of those fees that the cooperative placed in a
capital reserve fund was exempt under § 118(a).4
The Commissioner counters that these multi-part payments
"consisted of specific and ascertainable dollar amounts that were
paid solely for a purpose within the scope of Section 118." This
was not mentioned as a requirement in any of these cases and, in
fact, is not true. In each case, the transferor made one,
non-separated payment; it was the cooperative that divided it.
Furthermore, we note that the Commissioner does not even
attempt to distinguish Bear Valley Mut. Water Co. v. Riddell, 283
F. Supp. 949 (C.D.Cal.1968), aff'd, 427 F.2d 713 (9th Cir.1970) (per
curiam). In that case, shareholders paid periodic assessments and
received a free supply of water. These funds were mixed in with
4
See Concord Village, 65 T.C. 156; accord Cambridge
Apartment Bldg. Corp. v. Commissioner, 44 B.T.A. 617, 618-19 (1941)
(reaching the same conclusion under almost identical facts, except
that the excluded money was used to retire the cooperative's debt);
Appeal of Paducah & Ill. R.R., 2 B.T.A. 1001, 1006-07 (1925)
(reaching the same result with a corporation owned by two
railroads).
general funds, which were used to pay both current and capital
expenses. Despite the inherent difficulty in allocation, the court
ordered the bifurcation of the payments, opting to devise a formula
for determining the proper division. See id. at 960; accord San
Antonio Water Co. v. Riddell, 285 F. Supp. 297, 311 (C.D.Cal.1968),
aff'd, 427 F.2d 713 (9th Cir.1970) (per curiam).
b.
By contrast, we have not found any support for either the
Commissioner's or the Tax Court's position. The precedent cited by
the Commissioner in support of the "dominant purpose" theory does
not do so.
In United Grocers, Ltd. v. United States, 308 F.2d 634 (9th
Cir.1962), members of a buying cooperative were required to pay
annual dues, which the cooperative claimed were contributions to
capital. The court disagreed, noting that the dominant purpose for
paying dues was to qualify for the low-price goods and services
supplied by the cooperative. See id. at 639. The court held, as
a matter of fact, that there was no investment motive or desire to
benefit the community. See id. at 640. Without such a motive, no
part of the payment qualified as a nontaxable contribution to
capital. Consequently, the court had no occasion to consider the
possibility of bifurcation.
Similarly, in Putoma Corp. v. Commissioner, 601 F.2d 734, 751
(5th Cir.1979), we faced a single-part payment, none of which was
for a specific service, and thus we had no opportunity to consider
the merits of bifurcation. The only case cited by the Tax Court,
Federated Dep't Stores, Inc. v. Commissioner, 51 T.C. 500, 1968 WL
1414 (1968), aff'd, 426 F.2d 417 (6th Cir.1970), suffers the same
infirmity.5
4.
Finally, we note that the Commissioner's and Tax Court's
proposals are bad policy. According to the Tax Court, if a company
receives $10 million to locate an office supply factory in Houston
and agrees to supply city employees with pencils, the entire $10
million is taxable. That result would force persons to refrain
from economically-efficient transactions.
The Commissioner's rule would be even worse. Under the
"dominant purpose" test, if Houston paid the same company $400,000,
of which $199,999 was for office supplies and $200,001 was to
induce investment, the entire amount would be exempt under §
118(a). This would allow for structuring opportunities that would
result in substantial underpayment of taxes.
III.
A.
The Tax Court did not attempt to determine what portion of the
restricted pesos was in exchange for debt extinguishment and what
portion was for inducing investment. Under other circumstances, we
might remand to the Tax Court to make that factual determination.
On the state of the record before us, however, we need not remand.
When property with a readily ascertainable value is exchanged
5
The Federated court stated that § 118(a) applies "where
contributors anticipate only the indirect benefit of increased
business." Id. at 519. Although this statement appears to support
the Tax Court's theory, it is taken out of context. In the context
of a single-part payment, this is the correct standard. It does
not purport to inform our treatment of a multi-part payment.
for property without one, the latter property is presumed to be
equal in value to the former. See United States v. Davis, 370 U.S.
65, 72, 82 S. Ct. 1190, 1194, 8 L. Ed. 2d 335 (1962). This principle
of tax law has been reaffirmed many times.6 It reflects the common
sense notion that an asset's value is the price persons are willing
to pay for it.
G.M. surrendered $600,000 of debt to the Mexican government
in exchange for a unknown amount of restricted pesos, each worth an
unknown amount. This was an arms-length transaction with real
economic substance. Absent a readily-ascertainable value for the
amount and worth of the pesos exchanged for that debt
extinguishment, we must follow Davis and assume that value received
for $600,000 of debt is, in fact, $600,000.
B.
We have examined the record carefully. The Commissioner
presented considerable evidence about the value of the full 1.7
6
See, e.g., Keener v. Exxon Co., USA, 32 F.3d 127, 132 (4th
Cir.1994) ("An actual price, agreed to by a willing buyer and a
willing seller, is the most accurate gauge of the value the market
places on a good."); Dessauer v. Commissioner, 449 F.2d 562, 566
(8th Cir.1971); Bar L Ranch, Inc. v. Phinney, 426 F.2d 995, 1001
(5th Cir.1970); Pulliam v. Commissioner, 329 F.2d 97, 99 (10th
Cir.1964); see also United States v. Garber, 607 F.2d 92, 97 (5th
Cir.1979) (en banc) (assuming, without deciding, the applicability
of Davis ); cf. United States v. Cartwright, 411 U.S. 546, 551,
93 S. Ct. 1713, 1716, 36 L. Ed. 2d 528 (1973) ("The willing
buyer-willing seller test of fair market value is nearly as old as
the federal income, estate, and gifts taxes themselves....");
McDonald v. Commissioner, 764 F.2d 322, 329 (5th Cir.1985) ("We
express initially a strong disinclination to disturb the
established meaning of the term "fair market value' as it was
enunciated by the Supreme Court in United States v. Cartwright
...."). But cf. Mitchell v. Commissioner, 590 F.2d 312, 314 (9th
Cir.1979) (cautioning that the Davis rule should be applied only as
a last resort).
billion restricted pesos.7 Such evidence is irrelevant in light of
our determination that a portion of those restricted pesos
constitutes a nontaxable contribution to capital. The Commissioner
presented no evidence whatsoever regarding what portion of the
restricted pesos was in exchange for debt extinguishment. As the
Commissioner stated in a brief before the Tax Court, "there is no
evidence in the record as to the proper allocation between these
segments."
On the basis of this record, we conclude that the portion of
7
The Tax Court found that a restricted peso is equal in value
to an unrestricted peso. In so finding, it decided that an
arms-length purchaser would pay the same amount for a peso he could
use as he saw fit as he would pay for a peso in an account
controlled by the Mexican government, that could be used only for
the construction of a plant in Acuña built with Mexican goods and
services, and that would never be in the hands of the purchaser
because the Mexican government would pay the Mexican vendors
directly.
Although the Commissioner presented considerable evidence
about the effect of the restrictions on Procesos's stock, the
evidence presented about the effect of the restrictions on the
pesos was thin. The Commissioner demonstrated that the
interest paid on the unrestricted pesos was not restricted,
but the Commissioner did not explain the significance of this
fact. The Commissioner also alleged, with absolutely no
factual support, that the restrictions on the pesos were
similar to those usually placed on loans and that G.M. would
have built the plant in Acuña (presumably, using only Mexican
labor and products) in any event.
Other than that ambivalent information, the
Commissioner's expert assumed that the restricted pesos were
worth their face value, defending that assumption with this
statement: "It seems to me just obvious on its face that at
that cross-section of time, Procesos was in control of pesos
whose dollar value was equal to $1,044,000." Considering that
it is uncontested that Procesos never controlled the
restricted pesos, this is a remarkable statement. Although we
are at a loss to understand how the Tax Court came to the
conclusion it did, we need not determine the proper valuation
of the restricted pesos, as a large portion of these pesos
constitutes a nontaxable contribution to capital.
the restricted pesos given in exchange for debt extinguishment has
no readily ascertainable value.8 Therefore, following Davis and
its progeny, we decide that the portion of the restricted pesos
granted in exchange for debt extinguishment was worth what was paid
for it: $600,000.
As the Tax Court once stated, "[t]he wearing of judicial robes
does not require that we take leave of common sense."9 The
Commissioner would have us believe—despite a complete lack of
record evidence—that the Mexican government was unable to value its
own national debt and, therefore, paid substantially more than its
fair market value. The Davis rule exists precisely to defeat such
self-serving and incredible assertions.
C.
In summary, G.M. surrendered to the Mexican government a debt
worth exactly $600,000, for which it paid $600,000. As we have
found, the property received in exchange for this debt was worth
$600,000. The excess value of that property properly is a
8
We are uncertain which party has the burden of proof on this
point. See Leo P. Martinez, Tax Collection and Populist Rhetoric:
Shifting the Burden of Proof in Tax Cases, 39 HASTINGS L.J. 239, 258
(1988) (noting the confusion in the caselaw). Compare TAX CT. R.
142(a) ("The burden of proof shall be upon the petitioner ....")
with Carson v. United States, 560 F.2d 693, 696 (5th Cir.1977) ("In
a Tax Court deficiency proceeding, once the taxpayer has
established that the assessment is erroneous, the burden shifts to
the government to prove the correct amount of any taxes owed.").
For purposes of this appeal, we assume arguendo that the burden of
proof remains with the taxpayer. Nonetheless, the lack of evidence
in the record about the value of the portion of the restricted
pesos given in exchange for debt extinguishment is, in and of
itself, strong evidence that those pesos had no readily
ascertainable value. G.M. has met its burden.
9
Freytag v. Commissioner, 89 T.C. 849, 878, 1987 WL 45307
(1987), aff'd, 904 F.2d 1011 (5th Cir.1990), aff'd, 501 U.S. 868,
111 S. Ct. 2631, 115 L. Ed. 2d 764 (1991).
nontaxable contribution to capital under § 118(a). Accordingly,
G.M. recognized no gain from the Transaction.10
REVERSED and RENDERED.
10
G.M.'s basis in the property it acquired as a contribution
to capital is zero. See 26 U.S.C. § 362(c)(1). Therefore, G.M.
presumably will pay taxes on the contribution when it sells or
liquidates the factory.