105 T.C. No. 22



                UNITED STATES TAX COURT



NORTHERN INDIANA PUBLIC SERVICE COMPANY, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 24468-91.                     Filed November 6, 1995.



     P, a domestic utility company, formed F as a
subsidiary corporation in the Netherlands Antilles.
F's only activity was to borrow money by issuing
Euronotes and then lend the proceeds to P at an
interest rate that was 1 percent greater than the rate
on the Euronotes. Sec. 1441, I.R.C., generally
requires a domestic taxpayer to withhold a 30-percent
tax on interest paid to nonresident aliens. However,
payments to Netherlands Antilles corporations were
exempted from this tax pursuant to treaty. R
determined that F was a mere conduit or agent of P,
that P should be treated as having paid interest
directly to the Euronote holders, and that P is
therefore liable for the withholding tax.

     Held: F engaged in the business activity of
borrowing and lending money. F was not a mere conduit
or agent. The treaty exemption applies. P is not
liable for the withholding tax.
                               - 2 -

     Lawrence H. Jacobson, David C. Jensen, and Michael L. Brody,

for petitioner.

     Elsie Hall, Reid M. Huey, and Monique I.E. van Herksen,

for respondent.



     RUWE, Judge:   Respondent determined deficiencies in

petitioner's Federal income taxes as follows:


                     Year        Deficiency

                    1982        $3,785,250
                    1983         3,785,250
                    1984         3,785,250
                    1985         3,785,250


The sole issue for decision is whether petitioner was required,

pursuant to section 1441,1 to withhold tax on amounts of interest

paid to nonresident aliens.   If the answer is yes, petitioner is

liable for the tax pursuant to section 1461.2




     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
     2
      In Northern Ind. Pub. Serv. Co. v. Commissioner, 

 (1993), we denied petitioner's motion for partial summary
judgment and held that the special 6-year period of limitations
contained in sec. 6501(e)(1) applies where the income subject to
withholding tax under sec. 1441 is understated by an amount in
excess of 25 percent of the amount of gross income stated on Form
1042.
                                - 3 -

                           FINDINGS OF FACT


     Some of the facts have been stipulated and are so found.

The stipulation of facts, second, third, and fourth stipulations

of facts, and attached exhibits, respectively, are incorporated

herein by this reference.

     Petitioner is an Indiana corporation with its principal

office in Hammond, Indiana.    Petitioner's wholly owned foreign

subsidiary, Northern Indiana Public Service Finance N.V.

(Finance), was incorporated on August 21, 1981, in Curacao under

the Commercial Code of the Netherlands Antilles for an unlimited

term.   Finance had 20 shares of stock issued and outstanding, all

of which were acquired by petitioner for $20,000 cash.    Finance's

sole managing director throughout its existence was Curacao

Corporation Company N.V.    Finance's books and records were

maintained by its managing director in the Netherlands Antilles.

     Article 2 of Finance's articles of incorporation provides:


     The purpose of the company is to finance directly or
     indirectly the activities of the companies belonging to
     * * * [petitioner] * * *, to obtain the funds required
     thereto by floating public loans and placing private
     loans, to invest its equity and borrowed assets in the
     debt obligations of one or more companies of * * *
     [petitioner], and in connection therewith and generally
     to invest its assets in securities, including shares
     and other certificates of participation and bonds, as
     well as other claims for interestbearing debts however
     denominated and in any and all forms, as well as the
     borrowing and lending of monies.


Specifically, Finance was organized for the purpose of obtaining
                               - 4 -

funds so that petitioner could construct additions to its utility

properties.   To accomplish this, Finance was to issue notes in

the Eurobond market.   The Eurobond market has been aptly

described in a 1984 Senate Finance Committee report as follows:


          A major capital market outside the United States
     is the Eurobond market. It is not an organized
     exchange, but rather a network of underwriters and
     financial institutions that market bonds issued by
     private corporations (including but not limited to
     finance subsidiaries of U.S. companies), foreign
     governments and government agencies, and other
     borrowers.

          In addition to individuals, purchasers of the
     bonds include institutions such as banks (frequently
     purchasing on behalf of investors with custodial
     accounts managed by the banks), investment companies,
     insurance companies, and pension funds. There is a
     liquid and well-capitalized secondary market for the
     bonds with rules of fair practice enforced by the
     Association of International Bond Dealers. Although a
     majority of the bond issues in the Eurobond market are
     denominated in dollars (whether or not the issuer is a
     U.S. corporation), bonds issued in the Eurobond market
     are also frequently denominated in other currencies
     (even at times when issued by U.S. multinationals).
     [S. Prt. 98-169 (Vol. I), at 417 (1984).]


     On August 28, 1981, petitioner filed a petition with the

Public Service Commission of Indiana for a certificate of

authority and an order approving and authorizing petitioner to:

(1) Issue a note or notes in an amount not to exceed $75 million

to Finance; (2) pay all expenses of issuance of its notes and the

Euronotes connected therewith; and (3) apply the net cash

proceeds from the loan of the Euronote proceeds as requested in

the petition.   Essentially, the petition provided that the
                               - 5 -

proceeds were to be added to petitioner's working capital for

ultimate application to the cost of its construction project,

including the payment of short-term borrowings made to provide

funds for the construction project.    Petitioner also stated the

following in its petition to the Public Service Commission of

Indiana:


     It is believed that the Notes issued in conjunction
     with the Finance Subsidiary's issue and sale of the
     Euronotes, could be issued at a relatively favorable
     interest rate compared to domestically issued,
     unsecured long-term debt of petitioner and would allow
     petitioner additional flexibility in funding its
     construction program.


     On September 25, 1981, the Public Service Commission of

Indiana issued a certificate of authority providing that

petitioner was authorized to borrow the proceeds of the Euronote

issue and, in return, was authorized to issue its note in an

amount not to exceed $75 million to Finance, at an interest rate

which would be 1 percent greater than that borne by the

Euronotes.   The certificate of authority also provided that

petitioner could unconditionally guarantee the amount of

principal, interest, and premium, if any, on the Euronotes in the

event of a default by Finance and that the guaranty would be a

direct unsecured obligation of petitioner and would rank equally

and ratably with all other unsecured senior debt of petitioner.

     On October 6, 1981, Finance was authorized by its managing

director to issue and sell $70 million of guaranteed notes that
                                 - 6 -

would be due October 15, 1988.    This same day, petitioner's

executive and finance committee authorized and approved the

issuance of a $70 million note to Finance.

     On October 15, 1981, Finance issued notes in the Eurobond

market in the amount of $70 million, at an interest rate of 17-

1/4 percent.   The notes were listed on the stock exchange of the

United Kingdom and the Republic of Ireland.    The timely payment

of the principal amount and the interest was unconditionally

guaranteed by petitioner, and the notes contained a call option

in 1985 for a 1.5-percent premium, and in 1986 for a .75-percent

premium.   Also on October 15, 1981, petitioner issued a $70

million, 18-1/4 percent note due on October 15, 1988, to Finance,

and pursuant thereto, Finance remitted the net proceeds of the

Euronote offering of $68,525,000 to petitioner.3

     Petitioner and Finance issued a prospectus in connection

with the Euronote offering that was dated October 7, 1981.      The

prospectus provided that prior to the Euronote issuance,

petitioner was to contribute to Finance "cash or property in an

aggregate amount sufficient to bring total stockholder's equity

to $28,000,000."


     3
      Finance's Euronotes were issued at a discount of
$1,475,000, which Finance amortized over the term of the notes.
The discount consisted of $875,000 (1.25 percent) original
issuance discount, $262,500 (.375 percent) broker/manager
commission, $262,500 (.375 percent) underwriter commission, and
$75,000 for broker/manager out-of-pocket legal fees and expenses.
                               - 7 -

     In connection with the issuance of the Euronotes,

petitioner, Finance, and the Irving Trust Co. entered into an

Indenture Agreement on October 15, 1981.   This agreement

elaborates on the form and terms of the Euronote issuance and on

the responsibilities of the respective parties.   The agreement

provides, inter alia, that Finance's net worth will not be

reduced to an amount that is less than 40 percent of the

aggregate amount of its outstanding indebtedness.

     Also in connection with the Euronote offering, Eichhorn,

Eichhorn & Link issued a legal opinion letter dated October 7,

1981.   Based upon certain representations by petitioner, the

opinion letter stated that the Euronote holders would not be

subject to U.S. income tax upon receipt of interest income from

Finance, unless the holders were engaged in a U.S. trade or

business.   For purposes of this opinion letter, petitioner

represented, inter alia, that the equity capital of Finance at

the time of issuance of the Euronotes would not be less than $28

million, consisting of accounts receivable to be assigned to

Finance, and that Finance's net worth would not at any time be

reduced to an amount less than 40 percent of the aggregate amount

of its outstanding indebtedness, so as to maintain at all times a

debt-to-equity ratio not in excess of 2-1/2 to 1.

     On October 15, 1981, petitioner and Finance executed a

document captioned "Assignment of Accounts Receivable".     This

assignment was authorized by petitioner's board of directors on
                               - 8 -

September 22, 1981.   The assignment document provides that

petitioner assign all its "right, title and interest in and to

the accounts receivable" of five of petitioner's largest

customers:   United States Steel Corp.; Inland Steel Co.; Jones &

Laughlin Steel Corp.; Bethlehem Steel Corp.; and Midwest Steel

Corp., a division of National Steel Corp.     The assignment

document also provides that petitioner will act as a collection

agent for Finance with respect to the above accounts and that the

above accounts


     do now and at all times will aggregate in excess of
     $28,000,000, and in the event a decline in the value of
     one or more of the accounts would cause the aggregate
     amount to be less than $28,000,000, * * * [petitioner]
     will promptly assign additional customer accounts
     sufficient that the aggregate of all assigned accounts
     will be in excess of $28,000,000.


     On October 15, 1981, Eichhorn, Eichhorn & Link issued a

second legal opinion reaffirming its letter dated October 7,

1981, and stating that in its opinion, Finance was capitalized as

set forth in the prospectus.

     Petitioner did not change the manner in which it recorded

sales and accounts receivable information as a result of

executing the assignment document.     The moneys petitioner

collected on the accounts receivable that were listed in the

assignment document were not set aside in a special account, but

were placed in petitioner's general corporate funds.

Petitioner's audited financial statements covering September 1981
                                - 9 -

through September 1986 included the accounts receivable that were

listed in the assignment document.

     Petitioner did not send a letter notifying the account

debtors of the execution of the assignment document, nor did

petitioner file financing statements, as that term is defined in

the Uniform Commercial Code.   During the period the Euronotes

were outstanding, petitioner engaged in no borrowing transactions

in which any of its accounts receivable were pledged to an

unrelated third party or otherwise subject to a security interest

of an unrelated third party.   The balance of the accounts

receivable at all times relevant herein exceeded $28 million.

     Finance received annual interest payments in 1982, 1983,

1984, and 1985 in the amount of $12,775,000 from petitioner.

Finance made annual interest payments in the amount of

$12,075,000 in 1982, 1983, 1984, and 1985 to the holders of the

Euronotes.    Finance's aggregate income on the spread between the

Euronote interest and the interest on petitioner's note was

$2,800,000.   In addition, Finance earned interest income on its

investments (exclusive of interest paid by petitioner on its

note).

     On October 10, 1985, petitioner repaid its note plus accrued

interest and early payment premium to Finance.   The payment

consisted of $70 million in principal, $12,775,000 in interest

for the period ending October 15, 1985, and a $1,050,000 call

premium.   On October 15, 1985, Finance redeemed the Euronotes by
                              - 10 -

paying $70 million in principal, $12,075,000 in interest, and a

$1,050,000 call premium to the Euronote holders.

     On September 22, 1986, Finance was liquidated.   The

distribution of Finance's assets to petitioner was completed

sometime during 1987.

     Petitioner timely filed Forms 1042 (U.S. Annual Return of

Income Tax to be Paid at Source) for each of the years at issue.

Petitioner also filed Forms 1042S (Foreign Person's U.S. Source

Income Subject to Withholding) for all the payments reported on

the Forms 1042.   The interest payments made by Finance to the

Euronote holders were not reported in petitioner's Forms 1042 and

1042S or on any schedule or statement attached to such returns.


                              OPINION


     Section 871(a)(1) generally imposes a tax on nonresident

aliens of 30 percent of the amount of interest received from

sources within the United States.   Section 1441(a) and (b)

generally requires persons who pay such interest to deduct and

withhold a tax equal to 30 percent of the amount thereof.

Section 1461 makes the payor liable for this withholding tax.

     Section 894 provides that to the extent required by any

treaty obligation of the United States, income of any kind shall

be exempt from taxation and shall not be included in gross

income.   See Tate & Lyle, Inc. v. Commissioner, 

, 664

(1994).   During the tax years at issue, article VIII of the
                              - 11 -

income tax treaty between the United States and the Netherlands,

as extended to the Netherlands Antilles (Treaty), provided the

following:


          (1) Interest on bonds, notes, debentures,
     securities, deposits or any other form of indebtedness
     * * * paid to a resident or corporation of one of the
     Contracting States shall be exempt from tax by the
     other Contracting State. [Convention with Respect to
     Taxes, Apr. 29, 1948, U.S.--The Neth., art. VIII, 62
     Stat. 1757, 1761, supplemented by Protocol, Oct. 23,
     1963, 15 U.S.T. 1900, modified by Supplementary
     Convention, Dec. 30, 1965, 17 U.S.T. 896, 901.]


In light of this Treaty provision, if petitioner's interest

payments are recognized as having been paid to Finance, Finance

would not be liable for the tax imposed by section 871(a)(1), and

petitioner would be under no obligation to withhold tax pursuant

to section 1441.

     Respondent determined that petitioner was required to

withhold taxes pursuant to section 1441 on the interest payments

to the Euronote holders.   Respondent's position is based on the

proposition that Finance should be ignored and that petitioner

should be viewed as having paid interest directly to the Euronote

holders.   Respondent argues that Finance was a mere conduit or

agent in the borrowing and interest-paying process.

     Petitioner formed Finance for the purpose of borrowing money

in Europe and lending money to petitioner.   Normally, a choice to

transact business in corporate form will be recognized for tax

purposes so long as there is a business purpose or the
                                - 12 -

corporation engages in business activity.   As stated by the

Supreme Court:


          The doctrine of corporate entity fills a useful
     purpose in business life. Whether the purpose be to
     gain an advantage under the law of the state of
     incorporation or to avoid or to comply with the demands
     of creditors or to serve the creator's personal or
     undisclosed convenience, so long as that purpose is the
     equivalent of business activity or is followed by the
     carrying on of business by the corporation, the
     corporation remains a separate taxable entity. * * *
     [Moline Properties, Inc. v. Commissioner, 

,
     438-439 (1943); fn. refs. omitted.]


     The alternative requirements of business purpose or business

activity have been restated many times.   With respect to the

latter requirement, the quantum of business activity may be

rather minimal.   Hospital Corp. of America v. Commissioner, 

, 579 (1983).   Even where a corporation is created with a

view to reducing taxes, if it in fact engages in substantive

business activity, it will not be disregarded for Federal tax

purposes.   Bass v. Commissioner, 

, 601 (1968).     This

is true even if the primary reason for the corporation's

existence is to reduce taxes.    As we stated in Nat Harrison

Associates, Inc. v. Commissioner, 

, 618 (1964):


     Whether the primary reason for its existence and
     conduct of business was to avoid U.S. taxes or to
     permit more economical performance of contracts through
     use of native labor, or a combination of these and
     other reasons, makes no difference in this regard. Any
     one of these reasons would constitute a valid business
     purpose for its existence and conduct of business as
                              - 13 -

     long as it actually conducted business.[4] * * *


Considering these principles and the fact that Finance engaged in

the business activity of borrowing and lending money at a profit,

it would seem that Finance should be recognized as the recipient

of interest paid to it by petitioner.

     Of course, a corporate entity can act as an agent for its

sole shareholder rather than for its own account.    But these

instances have been rather narrowly restricted to situations

where the corporation's role as an agent is made clear; e.g.,

where the agency relationship is set forth in a written

agreement, the corporation functions as an agent, and the

corporation is held out as an agent in all dealings with third

parties related to the transaction.     Commissioner v. Bollinger,

 (1988).5   The facts before us do not fit this mold.

     4
      See also Ross Glove Co. v. Commissioner, 

, 588
(1973).
     5
      In Bass v. Commissioner, 

, 601 (1968), we
observed:


     Long ago, the Supreme Court held that when a
     corporation carries on business activity the fact that
     the owner retains direction of its affairs down to the
     minutest detail makes no difference tax-wise, observing
     that "Undoubtedly the great majority of corporations
     owned by sole stockholders are 'dummies' in the sense
     that their policies and day-to-day activities are
     determined not as decisions of the corporation but by
     their owners acting individually." National Carbide
     Corp. v. Commissioner, supra at 433; see Chelsea
     Products, Inc., 

, 851 (1951), affd. 197 F.2d
                                                   (continued...)
                              - 14 -

     Respondent does not deny the corporate existence of Finance.

Respondent's reason for treating Finance as a mere conduit or

agent is that Finance was "not properly capitalized".   The

explanation of adjustments in the notice of deficiency states:


     It has been determined that your 100% owned foreign
     subsidiary, incorporated in the Netherlands Antilles,
     was not properly capitalized, therefore the interest
     paid by that subsidiary on debt obligations (Euronotes)
     is treated as being paid directly by you.
     Consequently, you are liable for the 30% withholding
     which was not withheld on interest payments made to the
     holders of the Euronotes * * * [Emphasis added.]


     Respondent's argument that Finance was inadequately

capitalized, and that this should result in ignoring it for tax

purposes, appears to be based on Rev. Rul. 69-377, 1969-2 C.B.

231; Rev. Rul. 69-501, 1969-2 C.B. 233; Rev. Rul. 70-645, 1970-2

C.B. 273; and Rev. Rul. 73-110, 1973-1 C.B. 454.   These revenue

rulings basically recognize the validity of the debt obligation

of wholly owned foreign financing subsidiaries in situations

identical to the instant case, if the amount borrowed by the

financing subsidiary does not exceed five times its equity

capital.6   Respondent would agree that petitioner is not liable

     5
      (...continued)
     620 (C.A.3, 1952).
     6
      In Rev. Rul. 74-464, 1974-2 C.B. 47, respondent indicated
that the mere existence of a 5-to-1 debt-to-equity ratio could no
longer be relied upon by taxpayers.


                                                    (continued...)
                              - 15 -

for the withholding tax if Finance's debt-to-equity ratio does

not exceed 5 to 1.7

     Petitioner argues that its assignment of accounts receivable

in an amount of at least $28 million was an equity investment in

Finance that brings Finance well within the debt-to-equity ratio

of 5 to 1.   Respondent argues that this assignment was not an

equity investment because actual ownership of the accounts

receivable was never transferred.   Before we launch any inquiry

into the true nature of the assignment of petitioner's accounts

receivable, we will first inquire into the legal basis for

respondent's reliance on alleged inadequate capitalization as a


     6
      (...continued)
          In light of the inseparability of the IET
     [Interest Equalization Tax] and the five to one debt to
     equity ratio and resultant Federal income tax
     consequences, the expiration of the IET on June 30,
     1974, eliminated any rationale for treating finance
     subsidiaries any differently than other corporations
     with respect to their corporate validity or the
     validity of their corporate indebtedness. Thus, the
     mere existence of a five to one debt to equity ratio,
     as a basis for concluding that debt obligations of a
     finance subsidiary constitute its own bona fide
     indebtedness, should no longer be relied upon. [Id.]

     7
      As more fully discussed infra, sec. 127(g)(3) of the
Deficit Reduction Act of 1984 (DEFRA), Pub. L. 98-369, 98 Stat.
652, provides a "safe harbor" from taxation for interest paid to
a controlled foreign corporation if the requirements of the
above-mentioned revenue rulings are met. At trial, respondent's
counsel acknowledged that the specific capital requirements of
the revenue rulings outlined above were not based on statute or
case law, except to the extent that compliance with them is
required to come within the "safe harbor" provisions of DEFRA
sec. 127(g)(3).
                               - 16 -

reason for treating Finance as a conduit.

     Revenue rulings represent "merely the opinion of a lawyer in

the agency and must be accepted as such", and are "not binding on

the * * * courts."    Stubbs, Overbeck & Associates, Inc. v. United

States, 

, 1146-1147 (5th Cir. 1971); see Halliburton

Co. v. Commissioner, 

, 232 (1993), affd. without

published opinion 

 (5th Cir. 1994).    Accordingly, "a

ruling or other interpretation by the Commissioner is only as

persuasive as her reasoning and the precedents upon which she

relies."    Halliburton Co. v. Commissioner, supra at 232.     The

aforementioned revenue rulings contain no legal analysis

supporting their debt-to-equity requirement.    At trial, we asked

respondent's counsel to explain the legal foundation and

rationale upon which respondent's debt-to-equity position was

based.    Except for referring to the aforementioned revenue

rulings, counsel was unable to provide an explanation at that

time.    In respondent's opening brief, respondent cited no legal

authority supporting a debt-to-equity requirement.

     Petitioner takes the position that a debt-to-equity ratio is

irrelevant to whether a corporation is acting as a conduit or

agent.    In respondent's reply brief, she addresses petitioner's

argument that the debt-to-equity ratio is irrelevant by

attempting to distinguish the cases petitioner cited on the

ground that they did not deal with the type of

conduit/withholding transaction presented in this case.
                              - 17 -

Respondent's reply brief then states that


     in the case at bar, we are dealing with the question of
     debt to equity ratio in the context of a controlled
     foreign corporation, a financing subsidiary. The
     requirement of adequate capitalization serves as a
     major assurance that there is financial reality and
     substance to the transaction in the post Moline
     Properties, supra, era. [Fn. ref. omitted.]


However, respondent cites no authority for this proposition, nor

does she explain what factors should be used in determining the

existence of "adequate capitalization" in this situation.    It

would appear that this is an issue of first impression.

     There is nothing in Moline Properties, Inc. v. Commissioner,

 (1943), upon which respondent can rely.    In that

case, the taxpayer corporation was created and owned by an

individual who had previously purchased real estate that he had

mortgaged.   The investment proved unprofitable, and in order to

avoid losing the property, the individual owner was required by

his creditors to transfer title to the newly formed corporation

and place the corporate stock in trust as collateral.    See Moline

Properties, Inc. v. Commissioner, 

 (1941), revd. 

 (5th Cir. 1942), affd. 

 (1943).

     In Moline Properties, Inc. v. Commissioner, supra, the

Supreme Court upheld the Commissioner's position that the

corporate entity to which the real estate was transferred must be

recognized and pay tax on the profit realized when it sold the

real estate.   There is nothing in Moline Properties that suggests
                              - 18 -

that the Supreme Court placed any significance on the ratio of

debt to equity.   Indeed, from the facts presented in Moline

Properties, one would suspect that the creditors required the

transfer of real estate to the newly formed corporation, because

the individual debtor/stockholder had insufficient equity to

satisfy the creditors that the debts would be repaid.

     Moline Properties, Inc. v. Commissioner, supra, stands for

the general proposition that a choice to do business in corporate

form will result in taxing business profits at the corporate

level.   Neither party has directed our attention to precedent

that conditions this proposition on a ratio of debt to equity.

This does not mean that the relationship of debt to equity is

necessarily irrelevant in cases where there is a challenge to a

corporation's role.   But if the relationship of debt to equity is

to be a significant factor for tax purposes, it seems to us that

it must also have economic significance to the transaction being

challenged.

     In the instant case, if petitioner had invested sufficient

equity capital in Finance to bring the debt-to-equity ratio to 5

to 1, respondent would have conceded.   Petitioner could have

achieved this debt-to-equity ratio by contributing an additional

$14 million to Finance.8   But since Finance's only business


     8
      As previously noted, petitioner argues that it did achieve
a 5-to-1 debt-to-equity ratio when it assigned at least $28
million of accounts receivable to Finance.
                               - 19 -

purpose was to borrow money in Europe and lend money to

petitioner--and petitioner obviously needed the $14 million9--one

would naturally expect that a $14 million capital contribution

received by Finance would have been lent right back to

petitioner.   This would have presumably satisfied respondent's

debt-to-equity ratio, and respondent would not have characterized

Finance as a mere conduit.10   In reality, however, nothing of

economic significance would have occurred with respect to

Finance's issuance of Euronotes.   The financial stability of

Finance and the position of the Euronote holders would have been

substantially unchanged.   Both would have ultimately remained

dependent upon petitioner's ability to pay its notes to Finance,

so that Finance could in turn pay off the Euronotes.

     The legislative history of DEFRA describes the manner in

which domestic corporations accessed the Eurobond market:


          In general, debt securities in the Eurobond market
     are free of taxes withheld at source, and the form of
     bond, debenture, or note sold in the Eurobond market
     puts the risk of such a tax on the issuer by requiring
     the issuer to pay interest, premiums, and principal net
     of any tax which might be withheld at source (subject
     to a right of the issuer to call the obligations in the

     9
      The whole purpose of Finance was to facilitate petitioner's
borrowing $70 million.
     10
      Respondent did not contend on brief that a financing
subsidiary would be lacking in substance if it lent its capital
back to its parent, and nothing in respondent's revenue rulings
indicates the manner in which a financing subsidiary is required
to invest its capital.
                              - 20 -

     event that a withholding tax is imposed as a result of
     a change in law or interpretation occurring after the
     obligations are issued). Because the Eurobond market
     is generally comprised of bonds not subject to
     withholding tax by the country of source, an issuer may
     not be able to compete easily for funds in the Eurobond
     market solely on the basis of price if its interest
     payments are subject to a substantial tax. U.S.
     corporations currently issue bonds in the Eurobond
     market free of U.S. withholding tax through the use of
     international finance subsidiaries, almost all of which
     are incorporated in the Netherlands Antilles.

          Finance subsidiaries of U.S. corporations are usually
     paper corporations, often without employees or fixed assets,
     which are organized to make one or more offerings in the
     Eurobond market, with the proceeds to be relent to the U.S.
     parent or to domestic or foreign affiliates. The finance
     subsidiary's indebtedness to the foreign bondholders is
     guaranteed by the U.S. parent (or other affiliates).
     Alternatively, the subsidiary's indebtedness is secured by
     notes of the U.S. parent (or other affiliates) issued to the
     Antilles subsidiary in exchange for the loan proceeds of the
     bond issue. Under this arrangement, the U.S. parent (or
     other U.S. affiliate) receives the cash proceeds of the bond
     issue but pays the interest to the Antilles finance
     subsidiary rather than directly to the foreign bondholders.
     [S. Prt. 98-169 (Vol. I), at 418 (1984).]


The above description closely corresponds to the manner in which

petitioner sought access to the Eurobond market.

     Petitioner wanted to take advantage of favorable Eurobond

interest rates.   However, prospective lenders did not want to be

liable for the 30-percent tax imposed by section 871(a)(1).

Prospective lenders were willing to lend money to Finance because

it was a Netherlands Antilles corporation whose notes would not

be subject to tax under section 871(a)(1).   The business purpose

of Finance was to borrow money in Europe at a favorable rate and

lend money to petitioner.   For its involvement, Finance would
                              - 21 -

derive a profit equal to 1 percent of the amount lent to

petitioner; i.e., the difference between 17-1/4 percent and 18-

1/4 percent interest.   Obviously, the Euronote purchasers were

willing to buy Finance's notes without requiring that any

additional equity capital be invested in Finance.   Therefore,

regardless of how petitioner's assignment of accounts receivable

is characterized, petitioner's equity investment in Finance was

"adequate" to carry out Finance's business purpose.11

     Respondent relies almost exclusively on Aiken Indus., Inc.

v. Commissioner, 

 (1971).   In Aiken Indus., a domestic

corporation (U.S. Co.) borrowed $2,250,000 at an interest rate of

4 percent on April 1, 1963, from a Bahamian corporation

(Bahamian).   Bahamian owned 99.997 percent of U.S. Co.'s parent,

also a domestic corporation, which in turn wholly owned U.S. Co.

On March 30, 1964, Bahamian's wholly owned Ecuadorian subsidiary

incorporated Industrias Hondurenas S.A. de C.V. (Industrias) in

the Republic of Honduras.   On March 31, 1964 (which appears to be

1 day before U.S. Co.'s first interest obligation to Bahamian was

due), Bahamian assigned U.S. Co.'s note to Industrias in exchange

for nine promissory notes ($250,000 each), which totaled

$2,250,000 and bore interest of 4 percent.   Because of this

     11
      Cf. Bradshaw v. United States, 

, 

, 374 (1982) (citing Gyro Engg. Corp. v. United States, 

, 439 (9th Cir. 1969); Piedmont Corp. v. Commissioner,

, 890 (4th Cir. 1968), revg. T.C. Memo. 1966-263; Sun
Properties, Inc. v. United States, 

, 175 (5th Cir.
1955)).
                              - 22 -

assignment, U.S. Co. made its 4-percent interest payments to

Industrias, and Industrias made its 4-percent interest payments

to Bahamian.   Prior to the assignment, U.S. Co.'s interest

payments to Bahamian would have been subject to the withholding

provisions of section 1441.   But after the assignment, because

there was an income tax treaty between the United States and the

Republic of Honduras, U.S. Co. claimed exemption from the

withholding provisions.

     In Aiken Indus., Inc. v. Commissioner, supra, we held that

the corporate existence of Industrias could not be disregarded.

However, we also held that the interest payments in issue were

not "received by" Industrias within the meaning of the article of

the United States-Honduras Income Tax Treaty that exempted

interest from tax.   Id. at 933.   In Aiken Indus., Inc. v.

Commissioner, supra at 933-934, we stated:


     The words "received by" refer not merely to the
     obtaining of physical possession on a temporary basis
     of funds representing interest payments from a
     corporation of a contracting State, but contemplate
     complete dominion and control over the funds.

          The convention requires more than a mere exchange
     of paper between related corporations to come within
     the protection of the exemption from taxation * * *,
     and on the record as a whole, the * * * [taxpayer] has
     failed to demonstrate that a substantive indebtedness
     existed between a United States corporation and a
     Honduran corporation.

          * * * Industrias obtained exactly what it gave up
     in a dollar-for-dollar exchange. Thus, it was
     committed to pay out exactly what it collected, and it
     made no profit on the * * * [exchange of the notes]
                              - 23 -

     * * *

          In these circumstances, where the transfer of
     * * * the notes * * * left Industrias with the same
     inflow and outflow of funds and where * * * [all
     involved] were * * * members of the same corporate
     family, we cannot find that this transaction had any
     valid economic or business purpose. Its only purpose
     was to obtain the benefits of the exemption established
     by the treaty for interest paid by a United States
     corporation to a Honduran corporation. While such a
     tax-avoidance motive is not inherently fatal to a
     transaction, see Gregory v. Helvering, * * * [

, 469 (1935)], such a motive standing by itself is
     not a business purpose which is sufficient to support a
     transaction for tax purposes. See Knetsch v. United
     States, 

 (1960); Higgins v. Smith, 

 (1940); Gregory v. Helvering, supra.


     The fact that the transaction was entirely between related

parties was important to our conclusion that it was void of any

"economic or business purpose."   Aiken Indus., Inc. v.

Commissioner, supra at 934.   In contrast, Finance borrowed funds

from unrelated third parties (the Euronote holders) who were

willing to enforce their rights over both Finance and petitioner.

The Euronote holders would not have lent money to petitioner.

Finance was therefore created to borrow money in Europe and then

lend money to petitioner in order to comply with the requirements

of prospective creditors, a business purpose of the kind

recognized by the Supreme Court in Moline Properties, Inc. v.

Commissioner, 

 (1943).

     The instant case is also distinguishable from Aiken Indus.,

because Finance's borrowing and lending activity was a business

activity that resulted in significant earnings for Finance.
                             - 24 -

Petitioner was required to pay interest at 18-1/4 percent,

whereas Finance issued the Euronotes at 17-1/4 percent.

Finance's aggregate income on the spread between the Euronote

interest and the interest on petitioner's note was $2,800,000.

In addition, Finance earned interest income on its investments

(exclusive of interest received from petitioner) during its

existence.12

     Moreover, in Aiken Indus., this Court did not rely upon, or

even mention, lack of adequate capitalization as a reason for

treating Industrias as a conduit.   Since respondent's

determination was based on her finding that Finance was "not

properly capitalized," respondent's reliance on Aiken Indus. is

misplaced.

     Respondent next argues that


     in 1984 Congress had the option of retroactively
     grandfathering all foreign subsidiaries and eliminating
     all withholding tax on bond interest had it chosen to
     do so. Instead, it opted for the safe harbor provision
     contained in section 127(g)(3) which expressly
     referenced the rulings requiring a debt equity ratio of
     no more than five-to-one for financing subsidiaries
     utilized prior to the effective date of the Act. The
     intent of Congress, as reflected in this safe harbor

     12
      Compare Morgan Pac. Corp. v. Commissioner, T.C. Memo.
1995-418, in which the taxpayer conceded, based on Aiken Indus.,
Inc. v. Commissioner, 

 (1971), that a Netherlands
Antilles corporation should be treated as a conduit. The
transactions in Morgan Pacific are distinguishable from those in
the instant case. Among other things, the interest payments
received and paid by the Netherlands Antilles corporation in
Morgan Pacific were identical and the transactions did not
involve parties unrelated to petitioner.
                               - 25 -

     provision, is consistent with respondent's scrutiny of
     petitioner's debt to equity ratio and should be carried
     out. [Emphasis added.]


     The Deficit Reduction Act of 1984 significantly modified

withholding requirements with respect to "interest received by

foreigners on certain portfolio investments."    DEFRA sec. 127, 98

Stat. 648.    These provisions essentially provided U.S. taxpayers

direct tax-free access to the Eurobond market.   The amendments

made by DEFRA section 127 generally applied to "interest received

after the date of the enactment of this Act with respect to

obligations issued after such date, in taxable years ending after

such date."   DEFRA sec. 127(g)(1), 98 Stat. 652.   However, DEFRA

section 127(g)(3), 98 Stat. 652-653, established safe harbor

rules applicable to certain controlled foreign corporations in

existence on or before June 22, 1984:


          (A) In General.--For purposes of the Internal
     Revenue Code of 1954, payments of interest on a United
     States affiliate obligation to an applicable CFC in
     existence on or before June 22, 1984, shall be treated
     as payments to a resident of the country in which the
     applicable CFC is incorporated.

          (B) Exception.--Subparagraph (A) shall not apply
     to any applicable CFC which did not meet requirements
     which are based on the principles set forth in Revenue
     Rulings 69-501, 69-377, 70-645, 73-110.


Thus, respondent argues that for the safe harbor rules to apply,

the controlled foreign corporation must have met the 5-to-1 debt-

to-equity ratio as set forth in Rev. Rul. 69-377, 1969-2 C.B.
                              - 26 -

231; Rev. Rul. 69-501, 1969-2 C.B. 233; Rev. Rul. 70-645, 1970-2

C.B. 273; and Rev. Rul. 73-110, 1973-1 C.B. 454.

     Petitioner agrees that in order to fall within the safe

harbor provisions, Finance had to meet the debt-to-equity ratios

as set forth in the above revenue rulings.   Petitioner

nevertheless contends that "there is nothing in the 1984 Act, as

amended, or the accompanying legislative history, which suggested

that compliance with this safe harbor was the only method a

United States corporation could utilize in claiming an exemption

from U.S. withholding tax or interest paid to controlled foreign

finance subsidiaries."   Accordingly, petitioner contends that

irrespective of the capital requirements set forth in the

rulings, if the situation before us falls within the terms of the

Treaty, it is not liable for the withholding tax.   We agree.

     The legislative history of DEFRA describes in some detail

the practice of U.S. corporations seeking access to the Eurobond

market.   The legislative history notes that the offerings by

finance subsidiaries (mostly all of which were incorporated in

the Netherlands Antilles) "involve difficult U.S. tax issues in

the absence of favorable IRS rulings."   S. Prt. 98-169 (Vol. I),

at 419 (1984).   Indeed, the legislative history outlined the

arguments supporting the position taken by taxpayers and the

arguments supporting the Government's position with respect to

these "difficult U.S. tax issues".

     Notwithstanding this, no conclusion was drawn regarding the
                               - 27 -

merits of either position.    In fact, the legislative history

states that "these finance subsidiary arrangements do in form

satisfy the requirements for an exemption from the withholding

tax and a number of legal arguments would support the taxation of

these arrangements in accordance with their form."    S. Prt. 98-

169 (Vol. I), at 419 (1984).    Lastly, the legislative history

states:


       No inference should be drawn from this rule regarding
       the proper resolution of other tax issues. The
       conferees do not intend this provision to serve as
       precedent for the U.S. tax treatment of other
       transactions involving tax treaties or domestic tax
       law. [H. Conf. Rept. 98-861, at 938 (1984), 1984-3
       C.B. (Vol. 2) 1, 192; emphasis added.]


See also S. Prt. 98-169 (Vol. I), at 418 n.1 (1984).

       The fact that Congress made the safe harbor provisions of

DEFRA section 127(g)(3) contingent on meeting the requirements of

preexisting revenue rulings does not mean that such requirements

must be met in order for the legal substance of these financing

transactions to be recognized.    Congress was presumably trying to

provide a safe harbor for taxpayers who had complied with the

revenue rulings.    As already indicated, Congress did not intend

DEFRA section 127(g)(3) to be the exclusive means by which a

taxpayer could claim exemption from the 30-percent withholding

tax.    Moreover, Congress drew no conclusions regarding the

respective positions taken by taxpayers and the Government on

whether these transactions would qualify for exemption from
                              - 28 -

withholding tax.   Based on this, we are not convinced that

Congress was attempting to impart legitimacy to the debt-to-

equity ratio that was required by the revenue rulings.13

     13
      In Rev. Rul. 84-153, 1984-2 C.B. 383, the Commissioner
took the position that a Netherlands Antilles financing
subsidiary was a mere conduit for interest payments to foreign
bondholders even though the subsidiary was adequately
capitalized. The facts in Rev. Rul. 84-153, supra, are
essentially as follows: (1) P, a corporation organized under
the laws of the United States, owned 100 percent of the stock of
S, an Antilles corporation; (2) to upgrade the production
facilities of P's wholly owned domestic subsidiary, R, S sold
bonds to foreign persons in public offerings outside the United
States on Sept. 1, 1984; (3) S lent the proceeds from the bond
offerings to R at a rate of interest that was 1 percentage point
higher than the rate payable by S on the bonds; (4) R made timely
payments to S and S made timely payments to its bondholders; (5)
S's excess revenue after expenses was retained by S; (6) neither
P, R, nor S was thinly capitalized. The revenue ruling does not
mention any debt-to-equity ratio, nor does it explain the meaning
of "thinly capitalized". The revenue ruling concludes:


     In substance, S, while a valid Antilles corporation,
     never had such dominion and control over R's interest
     payments, but rather was merely a conduit for the
     passage of R's interest payments to the foreign
     bondholders. The primary purpose for involving S in
     the borrowing transaction was to attempt to obtain the
     benefits of the Article VIII(1) interest exemption for
     interest paid in form by R, a domestic corporation, to
     S, an Antilles corporation, thus, resulting in the
     avoidance of United States tax. This use of S lacks
     sufficient business or economic purpose to overcome the
     conduit nature of the transaction, even though it can
     be demonstrated that the transaction may serve some
     business or economic purpose. See Gregory v.
     Helvering, 

 (1935), and Aiken Industries,
     Inc., v. Commissioner, supra. * * * [Rev. Rul. 84-
     153, 1984-2 C.B. at 384.]


It is clear from this that the Commissioner would treat a
Netherlands Antilles finance corporation as a conduit, regardless
                                                   (continued...)
                              - 29 -

     Based on the facts and circumstances before us, we hold that

Finance did not act as a conduit or agent with respect to the

transactions in issue.   It follows that petitioner was not

required to withhold tax on interest payments to the Euronote

holders.14



                                         Decision will be entered

                                    for petitioner.




     13
      (...continued)
of whether it was adequately capitalized. However, Rev. Rul. 84-
153, supra, was modified by Rev. Rul. 85-163, 1985-2 C.B. 349, as
follows:


          Pursuant to the authority contained in section
     7805(b) of the Internal Revenue Code, the holdings of
     * * * Rev. Rul. 84-153 will not be applied to interest
     payments made in connection with debt obligations
     issued prior to October 15, 1984, the date that * * *
     Rev. Rul. 84-153 [was] published * * *


Finance issued its Euronotes on Oct. 15, 1981, approximately 3
years prior to the effective date of Rev. Rul. 84-153, as
modified by Rev. Rul. 85-163.

     14
      As a result of our conclusion, we need not address
petitioner's alternative argument that Finance met the capital
requirements of DEFRA sec. 127(g)(3) by virtue of the assignment
of petitioner's accounts receivable.