Container Corporation, Successor to Interest of Container Holdings Corporation, Successor to Interest of Vitro International Corporation v. Commissioner

CONTAINER CORPORATION, SUCCESSOR TO INTEREST OF CON-
TAINER HOLDINGS CORPORATION, SUCCESSOR TO INTEREST
OF VITRO INTERNATIONAL CORPORATION, PETITIONER v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 3607–05. Filed February 17, 2010.
Vitro, a Mexican corporation, charged P—one of its U.S.
subsidiaries—a fee to guarantee P’s debts. R determined a
deficiency for failure to withhold 30 percent of such fees as
‘‘fixed or determinable annual or periodical’’ income received
from a U.S. source under section 881(a), I.R.C. Held: The
guaranty fees are analogous to payments for a service and
therefore are not U.S. source income. Under sec. 1.861–4,
122
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(122) CONTAINER CORP. v. COMMISSIONER 123
Income Tax Regs., the source of the service is where the
service is performed. Because the guaranty was provided from
Mexico, fees for the guaranty are Mexican source income.
Thus, P didn’t need to withhold 30 percent of the guaranty
fees under section 881(a), I.R.C.
Emily A. Parker, for petitioner.
Dennis M. Kelly, for respondent.
OPINION
HOLMES, Judge: The Code puts a 30-percent tax on ‘‘fixed
or determinable annual or periodical’’ income received by for-
eign corporations from sources within the United States.
Vitro, S.A. is a Mexican corporation that charged one of its
U.S. subsidiaries a fee to guarantee the subsidiary’s debt to
U.S. lenders. The question presented in this case is whether
that fee is from a source within the United States.
Background
In 1901, Vitro, S.A. started making glass bottles for the
local beer makers of Monterrey, Mexico. Over the next cen-
tury, Vitro became one of Mexico’s most successful
businesses, eventually becoming a holding company and the
corporate parent of a large number of consolidated and
unconsolidated subsidiaries. These subsidiaries manufacture
and market a wide range of products, including just about
everything made from glass. Vitro provides administrative
and support services to its Mexican operating subsidiaries
through a wholly owned management subsidiary, Vitro
Corporativo, S.A. (Corporativo).
This case involves Vitro’s glass containers division. The
glass container business is driven by economies of scale—
greater production equals greater profits. And, in the late
1980s, Vitro—already Mexico’s largest manufacturer of glass
containers—decided to expand to the United States. It chose
to enter the market by acquisition, and its targets were two
U.S. companies, Anchor Glass Container Corp. and Latchford
Glass Co. Anchor was the second largest glass container pro-
ducer in the United States and a publicly traded company.
Latchford was a closely held regional glass container pro-
ducer headquartered in California.
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124 134 UNITED STATES TAX COURT REPORTS (122)
Vitro did not have glassmaking plants of its own in the
United States, but had inched into the market by organizing
marketing and distribution subsidiaries. In December 1988,
Vitro reorganized these subsidiaries, and formed Vitro Inter-
national Corp. as their U.S. holding company.
Then, in May 1989, Vitro organized C Holdings Corp. to be
an acquisition company. Vitro merged C Holdings into Con-
tainer Holdings Corp. in April 1990. (We refer to them collec-
tively as Container.) Container’s purpose was to help Vitro
gain control of Anchor and Latchford. As is common in take-
overs, Container then formed a shell corporation to acquire
Anchor’s and Latchford’s stock. The plan was that this
shell—THR Corp.—would get the stock, and then merge with
Anchor and Latchford to form one large operating subsidiary
under Container.
With the targets in sight and its squadron of acquisition
vehicles ready to roll, Vitro next had to arm itself with
financing. But here Vitro ran into a problem common to
Mexican companies in the late ‘80s—an inability to rely on
Mexican financing due to the peso devaluations of 1982 and
1987 which had left even the Mexican government
unfinanceable. This made Vitro unfinanceable, because
Standard & Poor or Moody’s will not give a borrower a
higher credit rating than that of its sovereign. Vitro needed
to look elsewhere. It turned to two U.S. investment banks—
Lazard, Freres & Co. and Donaldson, Lufkin & Jenrette
(DLJ)—for help in negotiating the financing and strategy of
what Vitro expected would be a hostile takeover.
Vitro wanted ultimately to finance the acquisition using a
combination of bank debt, equity, and high-yield (or, as
unwilling corporate targets usually called them, junk) bonds.
But before Vitro could get permanent financing, it needed
bridge financing for the tender offer. (Bridge financing is
short-term financing that aims to provide money for a trans-
action. It is meant to be repaid after a borrower closes the
transaction and can access the capital markets for a mix of
short- and long-term debt and equity financing.) DLJ com-
mitted up to $295 million in bridge financing to Vitro
because DLJ expected that once THR merged into Anchor and
Latchford it would be a creditworthy operating company. DLJ
formed Anchor Bridge Partnership with The Equitable
Companies (DLJ’s corporate parent) and a syndicate of banks
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(122) CONTAINER CORP. v. COMMISSIONER 125
to make the bridge loan to THR. Lazard and DLJ also lined
up the components of what they expected would be the
permanent financing for the acquisitions: hundreds of mil-
lions of dollars in bank loans and debt securities.
The plan began well. In the summer of 1989, Vitro and
Container started quietly buying Anchor stock on the open
market. Vitro contributed its shares to Container. By the end
of July 1989, Container held 10.1 percent of Anchor’s 14 mil-
lion outstanding shares. Vitro then made a tender offer for
the rest in August 1989. Anchor initially resisted, but after
testing the market for alternatives, surrendered. 1
The sale was set to close on November 2, 1989, but on
October 10, 1989, the junk-bond market collapsed when, in
a completely unrelated development, the management of
United Airlines found it could not finance its leveraged
buyout. Without a market for junk bonds, Vitro’s bridge
financing looked like it might turn into bridge-to-nowhere
financing. What followed was one temporary solution after
another.
Vitro first scrambled to find the money it needed to com-
plete the tender offer:
• On October 29, 1989, a group of banks led by Security
Pacific National Bank loaned THR $139 million. This SPNB
1989 tender offer loan was due in six months.
• On November 2, 1989, THR issued $155 million of senior
subordinated floating rates notes (THR 1989 bridge note) to
Anchor Bridge. The THR 1989 bridge note was due in one
year. 2
• On November 2, 1989, Container made a $128 million
equity contribution to THR in cash and Anchor and Latchford
stock in exchange for THR stock.
• On November 2, 1989, Container loaned $25 million to
THR (THR 1989 bridge loan). Vitro loaned $25 million to Con-
tainer to make the loan to THR. (Vitro 1989 bridge loan.)
Both loans were due in one year.
By the end of 1989, the deal looked like this:
1 In a friendlier takeover, Container also acquired all of Latchford’s stock during 1989. This
deal was much smaller than the Anchor acquisition, only about $41 million, and Latchford was
later merged into Anchor.
2 This THR 1989 bridge note is the one to keep an eye on in the diagrams below.
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126 134 UNITED STATES TAX COURT REPORTS (122)
After the tender offer closed, THR owned 99 percent of
Anchor’s stock. Anchor redeemed the rest for cash in May
1990, which made Anchor a wholly owned subsidiary of THR.
Vitro expected to refinance the SPNB 1989 tender offer loan
and the THR 1989 bridge note as soon as the junk-bond
market stabilized.
Then more bad news shattered any hopes Vitro had of
financing the deal through junk bonds: On February 13,
1990, Drexel Burnham Lambert filed for bankruptcy. Drexel
had created the high-yield bond market, but the market’s col-
lapse took Drexel with it and spurred a shift from debt to
equity in the financing of the takeovers. 3
On May 2, 1990, the SPNB 1989 tender offer loan became
due. Vitro needed more time. To buy some, Vitro refinanced
Anchor’s debt with a loan from the group of banks with SPNB
as their agent. SPNB divided the $268 million debt into two
loans (SPNB 1990 loans):
3 For a summary of Drexel’s collapse see Siconolfi et al., ‘‘Rise and Fall: Wall Street Era Ends
As Drexel Burnham Decides to Liquidate’’, Wall St. J., Feb. 14, 1990, at A1.
Chart1.eps
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(122) CONTAINER CORP. v. COMMISSIONER 127
• A $208 million term loan to refinance existing Anchor
debt, pay related fees and expenses, and provide working
capital for Anchor.
• A $60 million revolving credit loan to provide working
capital for Anchor and Latchford (SPNB 1990 revolving loan).
The SPNB 1990 loans matured on July 31, 1994, and came
with two conditions:
• Vitro had to contribute $184 million to the capital of THR
through Container to repay the SPNB 1989 tender offer loan,
and repay a portion of principal due on the THR 1989 Bridge
Note as well as the accrued interest.
• SPNB could restrict the amount of other debt allowed at
Anchor and the amount of money that could be paid out of
Anchor to THR.
These conditions affected the THR/Anchor merger. When
THR issued the THR 1989 Bridge Note, it expected to
refinance the note after the merger, but SPNB’s restrictions
would not allow it to move that debt to Anchor as part of any
refinancing. As a result, DLJ and Vitro decided that they
needed to make the indebtedness more marketable if they
were going to refinance the THR 1989 Bridge Note without
Anchor.
Vitro decided that moving the Note to a U.S. subsidiary
outside the Container group would do this. It chose Inter-
national because that company had enough cashflow from its
operations to service at least part of the Note. DLJ requested
that Vitro guarantee the debt as consideration for the
restructuring. Vitro then restructured the Note through a
series of transactions:
• On May 2, 1990, International issued $151 million of
senior notes (International 1990 bridge note) to Anchor
Bridge, with $30 million of principal due December 31, 1990,
$26 million of principal due December 31, 1991, and the
unpaid principal balance due May 1, 1992. International
loaned the proceeds to THR. Vitro guaranteed the Inter-
national 1990 bridge note.
• On May 2, 1990, THR issued a $151 million note (THR
1990 senior note) to International. THR used the proceeds to
repay the balance of the THR 1989 Bridge note. 4 The THR
4 With the THR 1989 bridge note paid, shift attention to this THR 1990 senior note and the
International 1990 Bridge note described above.
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128 134 UNITED STATES TAX COURT REPORTS (122)
1990 senior note was a ‘‘pay-in-kind’’ 5 note because of the
SPNB restrictions on Anchor, and Vitro expected that money
from Anchor would eventually pay the note. The THR 1990
senior note matured April 2, 1995.
• On May 2, 1990, the Vitro 1989 Bridge Loan was con-
verted into equity and canceled.
To make the first payment on the International 1990
Bridge note, International borrowed $31 million from Banca
Serfin (Banca Serfin 1990 loan), a Mexican bank. Vitro
guaranteed International’s obligations under the Banca
Serfin 1990 Loan. The Banca Serfin 1990 Loan matured in
March 1991.
All this work on the financing side of the deal would have
been fruitless without success on the operations side. And
there the initial hopes that Vitro brought to the deal seemed
to be justified. By 1991 the increased production capacity
was having the desired effect, and Vitro’s margins on glass
containers were improving. With higher margins, Anchor
increased its annual cashflow from $100 million to $200 mil-
lion. But with the financial markets still depressed, Vitro
and DLJ agreed that they needed to refinance one more time
before they could finally move the debt to Anchor.
To refinance the debt, International was to issue 21 senior
notes (together, the International 1991 senior notes) worth a
total of $155 million. The problem was that no one expected
International to have sufficient cashflow to make the pay-
ments on the International 1991 senior notes unless THR
made its payments on the THR 1990 senior note. But THR was
not required to make payments; remember, the THR 1990
senior note was a pay-in-kind note. DLJ advised that for
International to take on that amount of debt it would need
some credit support or the notes would not be marketable.
The needed credit support came from Vitro’s guaranty of
the International 1991 senior notes. The guaranty allowed
the note purchasers to collect from Vitro if International
defaulted. Vitro was chosen as guarantor over Anchor
because it had a lower debt-to-equity ratio than Anchor, and
SPNB’s restrictions on Anchor would not allow the latter to be
a guarantor. On March 28, 1991, International issued the
5 A ‘‘pay-in-kind’’ note allows the borrower to increase the principal of the note rather than
pay interest in cash.
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(122) CONTAINER CORP. v. COMMISSIONER 129
International 1991 senior notes to a group of U.S. insurance
companies and Vitro guaranteed the notes pursuant to a
guaranty agreement.
Here’s the graphic:
International used the proceeds to repay and cancel the
International 1990 Bridge note and Banca Serfin 1990 Loan.
International made the following guaranty-fee payments to
Vitro on the International 1991 senior notes: 6
Year Amount
1992 ...................................................................... $2,309,758
1993 ...................................................................... 1,912,867
1994 ...................................................................... 2,485,470
It is the tax treatment of these fees that is at issue in this
case. The guaranty agreement set the fee at 1.5 percent of
6 International also paid a guaranty fee for Vitro’s guaranty of the International 1990 Bridge
note, but paid it in 1991, a year not at issue here.
Chart2.eps
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130 134 UNITED STATES TAX COURT REPORTS (122)
the outstanding principal balance of the notes per year. This
1.5-percent fee was standard—Vitro charged all of its
subsidiaries the same fee no matter the subsidiary’s capital
structure or financial condition. And Vitro’s willingness to
guarantee its subsidiaries’ debt was not limited to Inter-
national: Vitro’s policy was to give a guaranty to any sub-
sidiary whenever it asked for one. The fees were not tied to
the amount of work Vitro did to negotiate or monitor the
guaranty. Vitro’s estatutos (or bylaws) expressly provided
that one of Vitro’s business purposes was to guarantee the
debts of its subsidiaries.
International did not withhold U.S. income taxes from the
fees. And, as expected, it also did not have the cashflow to
make the interest payments on the International 1991 senior
notes. To make those payments, Vitro and Container contrib-
uted almost $80 million in capital to International from 1990
to 1994. But the money didn’t help. At the end of 1993, soft-
drink producers began switching to plastic containers, and in
eighteen months the glass-container industry lost one-third
of its demand. And then a merger of other glass-container
producers knocked Vitro into third place in the U.S. market,
a now-shrinking market where it turned out there was room
for only two players. Anchor’s profits melted into losses. It
filed for bankruptcy in 1997.
The Commissioner’s response to this series of unfortunate
events was to determine that International should have with-
held 30 percent of the guaranty fees it paid to Vitro in 1992–
94. The Commissioner sent Container a notice of deficiency,
and Container timely petitioned us to redetermine its liabil-
ities. Container is a Delaware corporation with its principal
place of business in Texas. We tried the case in Dallas.
Discussion
Section 881(a) 7 imposes a 30-percent tax on ‘‘fixed or
determinable annual or periodical’’ (FDAP) income received
from sources within the United States by a foreign corpora-
tion, ‘‘but only to the extent the amount so received is not
effectively connected with the conduct of a trade or business
within the United States.’’ Taxes owed under section 881(a)
7 Unless otherwise noted all section references are to the Internal Revenue Code for the years
in issue. The single Rule reference is to Tax Court Rule of Practice and Procedure 155.
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(122) CONTAINER CORP. v. COMMISSIONER 131
are generally supposed to be withheld at the source. Sec.
1442(a). Thus, for Container to be liable under section 881(a)
the guaranty fees must be: (1) FDAP income and (2) received
from a U.S. source. See secs. 881(a), 1441(a), (b), 1442(a).
The parties agree that the guaranty fees, paid regularly in
fixed amounts, are FDAP income. 8 The key question in this
case is whether the second requirement is met—was the
source of the guaranty fees the United States or Mexico?
We determine FDAP income’s source by using the rules in
sections 861 to 863. Two rules are especially important here.
The first is for interest—the rule is that the source of
interest is the residence of the obligor. Secs. 861(a)(1),
862(a)(1); sec. 1.861–2, Income Tax Regs. The Commissioner
would like the guaranty fees to be treated as interest,
because International is a U.S. company.
The second rule that’s especially important here is the rule
on services—that rule is that the source of services is where
the services are performed. Secs. 861(a)(3), 862(a)(3); sec.
1.861–4, Income Tax Regs. Container would like the guar-
anty fees to be treated as payments by International for a
service performed by Vitro in Mexico.
The sourcing rules are not comprehensive. If a category of
FDAP is not listed, caselaw tells us to proceed by analogy. In
other words, if the guaranty fees were neither interest nor
payment for services rendered, we would still have to figure
out whether they were more like interest or more like pay-
ment for services rendered (or, possibly, some other category
of FDAP that has a specific sourcing rule). See Hunt v.
Commissioner, 90 T.C. 1289, 1301 (1988); Howkins
v. Commissioner, 49 T.C. 689, 693–95 (1968); Bank of Am. v.
United States, 230 Ct. Cl. 679, 686, 680 F.2d 142, 147 (1982),
affg. in part and revg. in part 47 AFTR 2d 81–652, 81–1 USTC
par. 9161 (Ct. Cl. 1981).
A. Guaranty Fees as Interest
Interest is ‘‘compensation for the use or forbearance of
money.’’ Deputy v. du Pont, 308 U.S. 488, 498 (1940); Sharp
8 The Code defines FDAP income broadly, and includes in it virtually all kinds of income ex-
cept capital gains from the sale of property. See Wodehouse v. Commissioner, 337 U.S. 369, 393–
94 (1949); see also sec. 1.1441–2(a), Income Tax Regs. (defining FDAP income for the years at
issue); sec. 1.881–2(b), Income Tax Regs. (referring to definition of FDAP income in sec. 1.1441–
2, Income Tax Regs.). The current regulations—in effect for payments made after December 31,
2000—define FDAP income in section 1.1441–2(b)(1)(i), Income Tax Regs.
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132 134 UNITED STATES TAX COURT REPORTS (122)
v. Commissioner, 75 T.C. 21, 24 (1980), affd. 689 F.2d 87 (6th
Cir. 1982). We agree with the parties that Vitro’s guaranty
was not a loan to International, so the guaranty fees are not
interest.
B. Guaranty Fees as Payment for Services
Sections 861(a)(3) and 862(a)(3) specifically source ‘‘labor
or personal services,’’ and Container argues that that is what
Vitro performed for International. Under the Guaranty
agreement, Vitro was required to maintain records and
supply information to the note purchasers. It performed
these acts using Corporativo personnel, facilities, equipment,
and capital—all located in Mexico. Container asks us to find
that the guaranty fees were compensation for these services
and are therefore Mexican source income. See Commissioner
v. Piedras Negras Broad. Co., 127 F.2d 260 (5th Cir. 1942),
affg. 43 B.T.A. 297 (1941); Dillin v. Commissioner, 56 T.C.
228, 244 (1971) (explaining that where the benefits of the
services are received or where a guaranty agreement was
entered into does not affect the source of services).
The Commissioner does not challenge Container’s assertion
that Corporativo performed services, but argues that services
were not the predominant feature of the guaranty and should
be ignored for sourcing purposes. See Bank of Am., 230 Ct.
Cl. at 690, 679 F.2d at 149. Container responds by arguing
that providing services is not a possible feature of a guar-
anty, but that a guaranty is itself a service; indeed, that the
Code and regulations actually refer to guaranties as services.
We’ll therefore analyze Container’s arguments on this
point at some length. They flow from four sections of the
Code or regulations. The first is based on section 1.731–
2(e)(3)(iii), Income Tax Regs., which deals with partnership
distributions. This section does include the words ‘‘services’’
and ‘‘guarantees of obligations,’’ but it does not suggest that
a guaranty is a service. And ‘‘guarantees of obligations’’ is
actually tucked away in a parenthetical listing types of
equity interests. 9 Container’s two other references are also of
little help, 10 but Container also asks us to look at transfer
pricing of services under section 482.
9 This
regulation wasn’t issued until 1996. T.D. 8707, 1997–1 C.B. 128.
10 The
second is section 954(h), which defines a ‘‘lending or finance business’’ as the business
of, among other things, providing guaranties and rendering services or making facilities avail-
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(122) CONTAINER CORP. v. COMMISSIONER 133
This might be a useful guide. Section 482’s purpose ‘‘is to
ensure that taxpayers clearly reflect income attributable to
controlled transactions, and to prevent the avoidance of taxes
with respect to such transactions.’’ Sec. 1.482–1T(a)(1), Tem-
porary Income Tax Regs., 58 Fed. Reg. 5272 (Jan. 21,
1993). 11 For example, if a U.S. corporation guarantees a loan
made to its foreign subsidiary by a third party without
receiving compensation from the foreign sub, it could avoid
the income it would have incurred had it charged a fee. But
the guaranty adds some value, and the section 482 regula-
tions tell taxpayers that the U.S. parent should recognize the
amount it would have charged had the transaction been
made at arm’s length with an uncontrolled third party. See
sec. 1.482–1T(b), Temporary Income Tax Regs., 58 Fed. Reg.
5272 (Jan. 21, 1993). But this is just a summary of a general
rule. When it comes to deciding whether payments for a
guaranty are services in particular transfer-pricing situa-
tions, the Commissioner has struggled.
In General Counsel Memorandum (GCM) 38499 (Sept. 19,
1980), 12 the Commissioner agreed with a proposed revenue
ruling 13 concluding that the ‘‘guarantee of the parent con-
stitutes the performance of a service for the subsidiary.’’ The
Commissioner used section 1.482–2(b)(7)(v), Example (9),
Income Tax Regs., to reach this result.
Example (9). X is a domestic manufacturing corporation. Y, a foreign sub-
sidiary of X, has decided to construct a plant in Country A. In connection
with the construction of Y’s plant, X draws up the architectural plans for
the plant, arranges the financing of the construction, negotiates with var-
able in connection with providing guaranties. This subsection wasn’t even part of the Code until
1997, see Taxpayer Relief Act of 1997, Pub. L. 105–34, sec. 1175(a), 111 Stat. 990; and its only
relevance to solving the problem we face is that the words ‘‘service’’ and ‘‘guarantee’’ are in the
same subsection. Container also cites a group of cases that hold that guaranty fees are deduct-
ible as ordinary and necessary business expenses under section 162, see, e.g., A. A. & E. B.
Jones Co. v. Commissioner, T.C. Memo. 1960–284; Tulia Feedlot, Inc. v. United States, 3 Cl. Ct.
364 (1983), but do not explain how deductibility makes a guaranty a service.
11 Section 1.482–1T(g)(8), Temporary Income Tax Regs., 58 Fed. Reg. 5282 (Jan. 21, 1993), de-
fines ‘‘controlled transaction’’ as ‘‘any transaction or transfer between two or more members of
the same group of controlled taxpayers.’’ Controlled taxpayers are ‘‘taxpayers owned or con-
trolled directly or indirectly by the same interests.’’ Sec. 1.482–1T(g)(5), Temporary Income Tax
Regs., 58 Fed. Reg. 5282 (Jan. 21, 1993).
12 Although GCMs have no precedential value, they are ‘‘helpful in interpreting the Tax Code
when ‘faced with an almost total absence of case law.’ ’’ Morganbesser v. United States, 984 F.2d
560, 563 (2d Cir. 1993) (quoting Herrmann v. E.W. Wylie Corp., 766 F. Supp. 800, 802–03
(D.N.D. 1991)).
13 The proposed revenue ruling was never published. See Field Service Advice Memoranda,
1995 FSA LEXIS 135 at 16 (May 1, 1995).
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134 134 UNITED STATES TAX COURT REPORTS (122)
ious Government authorities in Country A, invites bids from unrelated
parties for several phases of construction, and negotiates, on Y’s behalf,
the contracts with unrelated parties who are retained to carry out certain
phases of the construction. Although the unrelated parties retained by X
for Y perform the physical construction, the aggregate services performed
by X for Y are such that they, in themselves, constitute a construction
activity. * * * [14]
The proposed revenue ruling also concluded that guaranty
fees should be sourced to the country where the financing is
secured and where the subsidiary resides because that is the
situs of the risk of default. In the General Counsel Memo-
randum, the Commissioner expressed reservations about that
conclusion and suspended further consideration. 15 GCM
38499 (Sept. 19, 1980).
We also have some caselaw. In Centel Commcns. Co. v.
Commissioner, 92 T.C. 612 (1989), affd. 920 F.2d 1335 (7th
Cir. 1990), we decided that the guaranties were not a service,
though in a very different context: A burgeoning telephone
interconnect business got a loan to provide it with operating
funds. Id. at 616. As a condition of the loan, the lender
required guaranties from three of the company’s share-
holders. Id. The shareholders signed the agreements without
compensation, but five years later they received stock war-
rants for their guaranties. Id. at 617–19. The issue we
decided was whether the warrants were given for the
performance of services under section 83(a). Id. at 626. We
held that ‘‘within the meaning of section 83’’ the shareholder
had not performed a service. Id. at 633.
‘‘[W]ithin the meaning of section 83’’ is the key. We did
characterize the guaranties as ‘‘shareholder/investor actions
to protect their investment * * * [that] as such do not con-
stitute the performance of services.’’ Id. at 632–33. But we
14 At the time of the GCM’s release, the section 482 regulations were in final form. In 1993,
temporary regulations were issued. 58 Fed. Reg. 5263 (Jan. 21, 1993). The final regulations were
issued in 1994, but didn’t go into effect until tax years beginning after October 6, 1994. T.D.
8552, 1994–2 C.B. 93. Throughout the regulation’s final-to-temporary-to-final journey, ‘‘Example
(9)’’ remained unchanged. But that example was removed from section 1.482–2 by T.D. 9278,
2006–2 C.B. 256.
15 Guaranties come up again in section 1.482–9T(b)(3)(ii)(H), Temporary Income Tax Regs., 71
Fed. Reg. 44489 (Aug. 4, 2006). That section excludes guaranties from the ‘‘services cost method’’
of pricing a ‘‘controlled services transaction.’’ Treatment of Services Under Section 482; Alloca-
tion of Income and Deductions From Intangibles; Stewardship Expense, 71 Fed Reg. 44466,
44474 (Aug. 4, 2006). But the Commissioner immediately cautions that the express exclusion
shouldn’t be read as a recognition of a general rule of inclusion: ‘‘[N]o inference is intended by
this exclusion that financial transactions (including guarantees) would otherwise be considered
the provision of services for transfer pricing purposes.’’ Id.
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(122) CONTAINER CORP. v. COMMISSIONER 135
also stressed that our decision turned on a question of fact:
whether the shareholders got the warrants in exchange for
services rendered as employees or independent contractors.
Id. at 629. The parties agreed the shareholders weren’t
employees, and we found that they were not independent
contractors because they were not in the business of guaran-
teeing loans. Id. at 632. We did not hold that providing a
guaranty is never a service, and noted that we were ana-
lyzing only the language of section 83. An analysis under
that section is quite different from an analysis under the
sourcing rules, but it nevertheless prompted the Commis-
sioner to rethink his position when the problem came up in
the transfer-pricing context again. This time he reasoned
that
The Centel decision increases the litigating hazards * * * . However, we
do not read this case as contradicting the position of the Service as estab-
lished in * * * G.C.M. 38499. Guarantees do not fit comfortably within
normal tax law concepts in a number of areas and, consequently, there are
substantial arguments that can be made against any possible analysis of
guarantees. * * * [1995 WL 1918236 (IRS FSA May 1, 1995).]
All we can conclude from this detour through transfer-
pricing law is that it will not help us reach a reasonable
conclusion on whether guaranties are services under section
861.
So we’ll fall back on the dictionary. The common meaning
of ‘‘labor or personal services’’ implies the continuous use of
human capital, ‘‘as opposed to the salable product of the per-
son’s skill.’’ 16 Under this definition, we find that Container
failed to prove that Corporativo performed sufficient ‘‘labor or
personal services’’ to justify the $6 million International paid
in guaranty fees over three years. Container presented very
little evidence about the specific acts Corporativo performed
and how much time it took to perform them. For example,
Container’s posttrial brief explains that the Guaranty agree-
ment required Vitro to ‘‘take certain actions, confirm certain
facts, provide certain information, and create and supply cer-
tain documents.’’ The Guaranty agreement required only
minimal accountings and reporting to the note purchasers. In
any event, the fees were not tied to the amount of work that
16 See Black’s Law Dictionary 890 and 1180 (8th ed. 2004) (defining ‘‘labor’’ and ‘‘personal
service’’).
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136 134 UNITED STATES TAX COURT REPORTS (122)
Vitro did, but to the amount of the outstanding principal that
Vitro was standing behind. This leads us to hold that Inter-
national did not pay the guaranty fees to Vitro as compensa-
tion for services. The value of Vitro’s guaranty stems ‘‘from
a promise made and not from an intellectual or manual skill
applied.’’ Bank of Am., 47 AFTR 2d at 81–657.
We therefore move on to reasoning by analogy, and ask
whether guaranty payments are more like interest or more
like services.
C. Guaranty Fees as Analogous to Interest or Payments for
Services
When we source FDAP income by analogy, our goal is to
find the ‘‘source of income in terms of the business activities
generating the income or * * * the place where the income
was produced. Thus, the sourcing concept is concerned with
the earning point of income or, more specifically, identifying
when and where profits are earned.’’ Hunt, 90 T.C. 1301
(citation omitted).
There are only a few examples in the caselaw of sourcing
by analogy. Alimony was the first. The question of its source
arose when a U.S. resident paid alimony to his British ex
from an English bank. We held that the alimony’s source was
the ex-husband’s residence, and not where the funds were
deposited or where the divorce decree was entered. See Man-
ning v. Commissioner, 614 F.2d 815 (1st Cir. 1980), affg. T.C.
Memo. 1979–146; Howkins, 49 T.C. 694. Taking perhaps
too modern a view of marriage, we reasoned that alimony,
like interest, is not exchanged for property or services. And
since interest is sourced to the residence of the obligor, so too
would we source alimony. Howkins, 49 T.C. 694.
Another example of sourcing by analogy came from the
Court of Claims in Bank of America. In that case, the court
sourced commissions received by Bank of America from for-
eign banks in connection with transactions involving
commercial letters of credit. Bank of Am., 230 Ct. Cl. at 680–
681, 680 F.2d at 143. The conflict in Bank of America, as in
this case, was whether the commissions should be sourced by
analogy to personal services or to interest. Id. at 686–687,
680 F.2d at 147.
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(122) CONTAINER CORP. v. COMMISSIONER 137
To understand the holding in Bank of America requires
some background in letters of credit. Such letters make trade
easier by allowing a bank, rather than the seller, to examine
a buyer’s credit. For example, when a U.S. exporter wants to
sell goods to a foreign buyer, assessing the creditworthiness
of the foreign buyer can be a problem. So, instead of having
the seller do it, the buyer requests a letter of credit from a
foreign bank and the foreign bank does the job. If the buyer
is creditworthy, the foreign bank (sometimes called the
opening bank) substitutes its credit for the buyer’s and com-
mits to pay the seller when certain conditions are met, e.g.,
presentment of an inspection certificate and a bill of lading
to the opening bank. After the opening bank pays the seller,
the buyer reimburses it. There are two types of commercial
letters of credit: sight and time. A sight letter of credit obli-
gates the opening bank to pay as soon as the seller meets the
conditions in the letter of credit. A time letter of credit obli-
gates the opening bank to pay on a specific future date if the
conditions were met. See id. at 681, 680 F.2d at 144.
BofA performed four kinds of transactions involving letters
of credit, and charged the opening bank commissions for
three of them. 17 It’s these three, and how the Court of
Claims sourced each of them that are useful here. The first
kind was an acceptance, and BofA received acceptance
commissions in two situations—if BofA determined that the
conditions of a time letter of credit had been met it would
stamp the letter accepted, obligating itself to pay any holder
in due course when the letter came due; or, if an opening
bank with an established line of credit with BofA wanted to
refinance a letter of credit, it would accept a time draft at a
discount to the face amount of the letter of credit.
The Court of Claims began its analysis by noting that both
these types of acceptance transactions are similar to a loan
and that the commissions ‘‘include elements covered by the
interest charges made on direct loans.’’ Id. at 689, 680 F.2d
at 148. The court also held that the predominant feature of
an acceptance transaction was the substitution of BofA’s
credit for that of the opening bank and not the services BofA
performed. Id. at 690, 680 F.2d at 149. These factors led the
17 BofA did not charge the opening bank to advise a letter of credit. It ‘‘advised’’ a letter of
credit by informing the seller that a letter was issued in its favor and forwarding the letter to
the seller.
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138 134 UNITED STATES TAX COURT REPORTS (122)
Court of Claims to source acceptance commissions by analogy
to interest, with the obligor being the opening bank. Id. at
689, 680 F.2d 148.
BofA also received confirmation commissions. It confirmed
sight letters of credit by advising the letter and committing
to pay the letter’s face amount after the seller met its condi-
tions. The opening bank reimbursed BofA by either pre-
paying it or by keeping an account that BofA could debit.
When the opening bank prepaid, BofA didn’t charge a
commission. Otherwise it charged a commission that
reflected its assumption of the risk that the foreign bank
could default. The Court of Claims again found that the
performance of services was a part of the deal but that its
predominant feature was BofA’s substituting its credit for
the opening bank’s. Id. at 691, 680 F.2d at 149–50. The court
also thus sourced confirmation commissions, as it had accept-
ance commissions, by analogy to interest and with the obligor
being the opening bank. Id. at 691–92, 680 F.2d at 150.
Finally, the Court of Claims examined negotiation commis-
sions. Negotiations took place when BofA determined if the
seller met the conditions for payment in the letter of credit.
After BofA performed a negotiation, it would forward the
papers to the opening bank, which would do an independent
check. The Court of Claims found that negotiation commis-
sions were paid for services performed in the United States
and were distinguishable from the other two types of
commission because the only risk that BofA assumed was
that it might improperly determine that the seller met the
conditions. Id. at 692, 680 F.2d at 150.
The Commissioner argues that Bank of America is control-
ling because acceptance and confirmation commissions, like
guaranty fees, are uses of another’s credit and are analogous
to interest. But, as the Commissioner thoughtfully concedes,
the ‘‘use’’ of credit is different in guaranties compared to
acceptance and confirmation of letters of credit. When BofA
confirmed or accepted a letter of credit, it assumed an
unqualified primary legal obligation to pay the seller—it
stepped into the shoes of the opening bank and substituted
its own credit for the opening bank’s. It was, in effect,
making a short-term loan and the commissions approximated
interest. Id. at 688–91, 680 F.2d at 148–50.
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(122) CONTAINER CORP. v. COMMISSIONER 139
Vitro’s case is different. It was augmenting International’s
credit, not substituting its own. But should this distinction
matter? We conclude that it should, and begin our expla-
nation by examining the effects of a default. When a debtor
defaults on a loan, he is defaulting on an existing primary
obligation. Default causes the creditor to lose the outstanding
principal because he has already extended funds to the
debtor. Interest is the creditor’s compensation for putting his
own money at risk. As in a loan, BofA put its money directly
at risk when it paid the seller, and it charged for the risk—
although it called that charge a ‘‘commission’’ rather then
‘‘interest’’. Vitro’s obligation was, in contrast, entirely sec-
ondary. Unlike a lender, Vitro was not required to pay out
any of its own money unless and until International
defaulted. And Vitro’s guaranty might not even put its
money at risk after default, because if International
defaulted and Vitro paid the 1991 International senior notes,
it would step into the note purchasers’ shoes and acquire any
rights that they had against International. See Putnam v.
Commissioner, 352 U.S. 82, 85 (1956). Vitro loses only if
International defaults and Vitro repays the 1991 Inter-
national senior notes (which transfers International’s obliga-
tion from the note purchasers to Vitro) and then Inter-
national defaults on the transferred debt.
Vitro’s guaranty therefore lacks a principal characteristic
of a loan because Vitro did not extend funds to International.
To find otherwise would require us to assume that at the
time of the guaranty, the 1991 International senior notes
was somehow a loan to Vitro. Neither party makes this argu-
ment. 18 Vitro’s later choice to subsidize International
through capital contributions—instead of allowing Inter-
national to default—does not affect our analysis. Capital con-
tributions also lack a distinguishing characteristic of a loan—
a promise to repay.
The Commissioner argues, however, that if guaranties are
unlike loans because the guarantor does not have to hand
over his money at the outset, guaranty fees may be like
18 Container makes an alternative argument that Vitro’s guaranty was in the nature of a sur-
ety bond and is subject to tax under section 4371 and not section 881(a), 1441, or 1442. This
argument requires us to disregard the Guaranty agreement as a separate obligation and treat
Vitro as if it were a party to the International 1991 senior notes. We are not persuaded and
find that the Guaranty agreement was a separate and distinct obligation.
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140 134 UNITED STATES TAX COURT REPORTS (122)
interest in some broader sense under Howkins. That case,
the Commissioner argues, held that alimony is analogous to
interest because it is not paid for property or services.
Howkins, 49 T.C. 694. Reading Howkins this way, how-
ever, is reading it less as a useful analogy than as creating
a default rule. Property and services are listed in sections
861 and 862, so by definition, any unlisted type of income is
not paid for property or services. And if we were to follow
such reasoning without qualification, we would source all
unlisted types of income by analogy to interest. But we read
Howkins more narrowly; we reasoned there that alimony is
analogous to interest because its source is the obligor.
Howkins, 49 T.C. 693. This logic also reminds us of the
goal of sourcing by analogy: namely, find the location ‘‘of the
business activities generating the income or * * * the place
where the income was produced.’’ Hunt, 90 T.C. 1301. So
we have to ask if there’s a useful analogy to guaranty fees
that would help us figure out, in some reasonable way, where
they are produced.
International paid Vitro to guarantee the 1991 Inter-
national senior notes. These fees compensated Vitro for
incurring a contingent future obligation to either pay Inter-
national’s debt or make a capital contribution. Vitro was able
to make this promise because it had sufficient Mexican
assets—and its Mexican corporate management had a suffi-
cient reputation for using those assets productively—to aug-
ment International’s credit and enable the long and complex
series of financings we charted at the beginning of this
opinion to keep going as long as it did. So we conclude that
it is Vitro’s promise and its Mexican assets that produced the
guaranty fees. 19
We do not choose International as the source of the income
because the guaranty fees were not like alimony: Alimony is
only an obligation to pay, because once a court orders one
spouse to pay alimony, nothing more is required of the other
spouse. Guaranty fees are different—they are payments for
a possible future action.
We think that makes guaranties more analogous to serv-
ices. Guaranties, like services, are produced by the obligee
19 The parties did not argue the point, but in this sense the guaranty fees were somewhat
analogous to rents or royalties for the use of Vitro’s goodwill, see sec. 862(a)(4), which would
also source them to Mexico rather than the United States.
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(122) CONTAINER CORP. v. COMMISSIONER 141
and so, like services, should be sourced to the location of the
obligee. See secs. 861(a)(3), 862(a)(3); Hunt, 90 T.C. 1301.
We realize that we are deciding a close question, but an
analogy to interest has too many shortcomings: Guaranty
fees do not approximate the interest on a loan; Vitro, not
International, produced the guaranty fees; and Vitro’s guar-
anty was not an obligation to pay immediately, but a promise
to possibly perform a future act.
Conclusion
We hold that International was not required to withhold
taxes on the guaranty fees that it paid Vitro because those
fees are Mexican source income. The parties settled various
other issues, however, so
Decision will be entered under Rule 155.
f
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