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.
 

1"G.M." stands for General Merchandise. It not related to

General Motors Corporation. 

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
 

2G.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. 

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
 

3The 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. 

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.
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. at 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
 

4See Concord Village, 65 T.C. at 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). 

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
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
 

5The 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. 

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
 

6See, 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). 

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
 

7The 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. 

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
 

8We 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. 

 

9Freytag 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). 

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
 

10G.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. 

nontaxable contribution to capital under § 118(a). Accordingly,

G.M. recognized no gain from the Transaction.10

REVERSED and RENDERED.