G.M. Trading Corp. v. Commissioner of Internal Revenue

G.M. Trading Corporation (GM) (defendant), a company based in Texas, organized a Mexican subsidiary called Procesos G.M. de Mexico, S.A. de C.V. (Procesos). The Mexican government had established a debt-equity-swap program, seeking to attract foreign firms to open Mexican subsidiaries to produce goods for export. In anticipation of participation in the debt-equity swap, a complex series of transactions followed. In organizing Procesos, GM took 996 shares in class A stock and contributed about US$8,000 in financing. Mexican government debt was selling at a discount of about 50 percent. Thus, GM agreed with an unrelated bank (bank) to pay US$600,000 for US$1.2 million in United States dollar-denominated debt of the Mexican government from the bank. After negotiations with the Mexican Ministry of Finance and Public Credit (finance ministry), the Mexican government agreed to convert the purchased US$1.2 million in debt into about Mex$1.7 million, a discount rate of 13 percent. GM then purchased the debt from the bank at the agreed price. The finance ministry deposited about Mex$1.7 million into a United States Treasury account in Procesos’s name. Procesos transferred about 174,000 shares of its class B stock to the Mexican government. These shares were then transferred to GM. The Mexican government debt that GM had purchased was given to the Mexican government and then cancelled. The money in the Treasury account in Procesos’s name was paid out on confirmation that the payments related to construction of Procesos’s Mexican plant. The account earned interest at rates varying from 40 percent to 153 percent, reflecting inflation rates in Mexico and the peso’s loss of value compared to the United States dollar. Procesos paid about Mex$1.9 million to set up its Mexican plant, which opened in the fall of 1988. The commissioner of Internal Revenue (plaintiff) determined that GM had realized a taxable gain as a result of GM’s participation in the debt-equity-swap transaction.