In G.M Trading Corp v Commissioner, 12 September 1997, the Fifth Circuit Court of Appeals reversed the Tax Court in a decision involving a debt-equity swap programme set up by the Mexican government. The Fifth Circuit held that a swap carried out pursuant to the programme resulted in part in a nontaxable contribution to capital and not in a taxable gain, as asserted by the US Internal Revenue Service and as held by the Tax Court.
Under the facts of the case, G.M. Trading purchased Mexican bonds denominated in US dollars with a face amount of USD 600,000 and surrendered the bonds to the Mexican government in exchange for a payment of pesos in the amount of USD 1,200,000 to G.M. Trading's Mexican subsidiary. The subsidiary's use of the pesos was restricted and its stock was restricted from disposition for a 10-year period. The IRS asserted that the exchange resulted in a taxable gain of USD 600,000 to G.M. Trading, i.e. the difference in the value of the debt and the value of the peso conversion.
The Court of Appeals held that the transaction should be bifurcated and treated in part as an extinguishment of the government debt in the amount of USD 600,000 and in part as a contribution to the subsidiary's capital that is nontaxable under IRC ä 118.
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