Corporacion de Ventas de Salitre y Yoda v. Commissioner

CORPORATION DE VENTAS DE SALITRE Y YODA DE CHILE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Corporacion de Ventas de Salitre y Yoda v. Commissioner Docket No. 97315. United States Board of Tax Appeals 44 B.T.A. 393; 1941 BTA LEXIS 1334; May 6, 1941, Promulgated *1334 1. Petitioner, a foreign corporation, realized gain from the purchase of its own American debentrues at a discount in a transaction taking place within the United States. 2. Interest accrued and paid on petitioner's american issue of debentures is not deductible from its income arising from such purchase. (Sec. 232, Revenue Act of 1934.) George E. Cleary, Esq., for the petitioner. George R. Sherriff, Esq., for the respondent. VAN FOSSAN *393 This proceeding involves the redetermination of a deficiency in the petitioner's income tax for its fiscal year ended June 30, 1935, in the sum of $8,844.10. Three issues are presented: 1. Did the petitioner realize a profit from its purchase of its own debentures at less than their face value? 2. If such profit was realized, was it taxable as income derived from sources within the United States? 3. Was the interest paid by the petitioner on its American issue of debentures allowable as a deduction from income realized by it from sources within the United States? FINDINGS OF FACT. The facts were stipulated and we adopt the stipulation as our findings of fact. In so far as material*1335 they are as follows: The petitioner is a corporation, organized on January 8, 1934, under Law 5350 of the Republic of Chile. Its principal office is at Santiago, Chile, and it has never maintained an office or place of business in the United States. Its books are kept and its returns are filed on the accrual basis of accounting. Its fiscal year ends on June 30. In 1931 two of the principal producers of nitrate in the Republic of Chile were Compania Salitrera Anglo-Chilena, a Chilean corporation, hereinafter called Anglo-Chilena, and the Lautaro Nitrate Co., Ltd., a British corporation, hereinafter called Lautaro. In 1931 Compania de Salitre de Chile, hereinafter called Cosach, was organized under a special statute, Law 4863, of Chile. The purposes of Cosach were to promote the general interest of the nitrate industry, to obtain, "through a central organization", the improvement of the industry, to promote scientific and technical investigation, to handle the propaganda, distribution and sale of nitrate *394 and its derivatives, to facilitate the transportation of nitrate products, to acquire and exploit nitrate grounds, and to do everything directly related to the*1336 nitrate industry. The Chilean Government granted to Cosach for exploitation the nitrate deposits constituting its physical reserves, to be used as needed and requested by Cosach. Law 4863 authorized the issuance by Cosach of series "A" and series "B" shares in equal amounts. Series A shares, totaling 1,500,000 pesos, were to belong to the Government. Series B shares, to be issued as needed and not to exceed an aggregate of 1,500,000 pesos, were to be paid for by the net value of nitrate organizations taken over or acquired by Cosach, and by cash. Under the law, in 1933 Cosach acquired the entire capital stock of Anglo-Chilena. In the same year Anglo-Chilena became the owner of 61 percent of ordinary (and controlling) shares of Lautaro. Also in the same year Cosach acquired the remaining 39 percent of such shares of Lautaro. In 1931 Cosach also acquired the nitrate lands and other assets of some thirty independent producers of nitrate in Chile. After these transactions in the year 1931, Cosach controlled practically the entire output of Chilean nitrate. Cosach issued to the Chilean Government its series A shares, on which during the years 1930, 1931, 1932, and 1933 it*1337 was required to pay specified minimum dividends. Cosach also issued series B of the shares to former stockholders of Lautaro and of Anglo-Chilena's corporate predecessor and likewise issued its series B preferred shares to the thirty-odd independent producers. In 1931 Cosach created three bond issues, one of which, the socalled secured bonds, is not material to this case. One of the bond issues, dated as of February 18, 1931, was created under a trust indenture between Cosach and the National City Bank of New York authorizing an issue by Cosach of so-called prior secured 7 percent bonds of the aggregate principal amount of $35,857,000, hereinafter called the American issue of Cosach 7 percent bonds. The purpose of this issue was to borrow money for corporate uses. For the same purpose and by a similar trust indenture, dated as of the same date, with an English trustee, there was authorized by Cosach an issue of prior secured 7 percent bonds of Pound 3,000,000 sterling, hereinafter called the English issue of Cosach 7 percent bonds. These two bond issues were secured by the collection and payment to the trustees of a charge of 60 gold pesos per ton of nitrate exported. At October 31, 1934, there*1338 were issued and outstanding $35,036,000 aggregate principal amount of the American issue of Cosach 7 percent bonds and Pound 2,726,100 sterling aggregate principal amount of the English issue of Cosach 7 percent bonds. There were originally issued $35,536,000 aggregate principal amount of the American issue of Cosach 7 percent bonds, of which bonds having a face value of $19,000,000 were *395 sold for cash at almost 91 percent of face value, all of which was paid out by Cosach in 1931. The balance of the American issue of Cosach 7 percent bonds was issued at face value to refund debts of Anglo-Chilena and of certain independent producers. The trust indenture securing the American issue of Cosach 7 percent bonds permitted Cosach to redeem them at specified premiums. Cosach agreed not to issue additional bonds or other obligations while the American issue was outstanding. Upon default all American bonds become due and payable. The indenture was to be construed according to the laws of New York and Cosach submitted to the jurisdiction of the state and Federal courts therein and also appointed the trustee to accept service of process on its behalf. From December 1931*1339 to March 1932 Anglo-Chilena borrowed $3,000,000 to carry on the combined operations of itself, Cosach, and Lautaro. All Cosach bonds went into default as to amortization in the spring of 1932 and as to interest on June 30, 1933. The bonds remained in such default thereafter. On January 2, 1933, the President of Chile, by presidential decree, held that Cosach had been illegally organized and operated and ordered its liquidation by commission. On February 2, 1933, Law 5133 was enacted granting the liquidating commission comprehensive powers to conduct business, to issue obligations, to execute contracts, and otherwise to operate the company. A moratorium against the collection of bonds and other obligations was also established. Pursuant to the provisions of Law 5350, under which the petitioner was organized, the liquidation commission returned the shares of stock of Lautaro and Anglo-Chilena to the persons who had acquired Cosach stock in connection with the acquisition of the shares of stock of Anglo-Chilena and Lautaro. The commission also turned over the nitrate lands and plants and other assets, which had been transferred to Cosach by the thirty or more independent producers, *1340 to a new Chilean corporation, Compania Salitrera de Tarapaca y Antofagasta, hereinafter called Antofagasta, also directed to be created according to the said Law 5350. The independent producers and their creditors received the shares and securities of Antofagasta. The liquidating commission thus disposed of all the assets of Cosach except the stocks of nitrate and iodine on hand as of June 30, 1933, to persons other than the petitioner. The nitrate and iodine stocks which had belonged to Cosach were transferred to petitioner at its organization in January 1934. The obligations of Cosach which the petitioner was to pay under Law 5350 equaled or exceeded the value of such nitrate and iodine stocks acquired by the petitioner from Cosach. These obligations consisted of claims of the Central Bank of Chile, the Government and other creditors of Cosach. The assets above mentioned *396 were the only ones which the petitioner received upon its organization and its issuance of the American and English issues and debentures. The material parts of Law 5350, either summarized or quoted, are as follows: Article 1 in part is as follows: Because the national interest so demands*1341 it, there is established in favor of the State, and on the conditions determined by this Law, a monopoly of the exportation of and trade in nitrate and iodine in Chile. Nevertheless, the President of the Republic, in accordance with the provisions of this law, may transfer of lease the right to the monopoly for a period not exceeding 35 years, to the legal entity with the name "Chilean Nitrate and Iodine Sales Corporation" (Corporacion de Ventas de Salitre y Yoda de Chile) which is created by this Law. Consequently, the exportation of and trade in these products may be undertaken only by the State or by the Corporation to which reference has been made. Article 2 in part is as follows: The objects of the Corporation are to acquire nitrate and iodine from the producing enterprises, to sell, export, transport and distribute nitrate and iodine, to effect propaganda and to effect, in general, the commercial and other operations and transfers expressed in this law and which constitute the purposes of the Corporation. Article 4 is as follows: In order to participate in the sales of nitrate and iodine every producer or producing enterprise must declare, in a notarial document, *1342 its adherence to the Corporation. This declaration shall be inscribed in the Register of Commerce of Valparaiso and, when this formality has been fulfilled, such declaring enterprise shall enjoy the rights and shall be subject to the obligations which under this law and the By-Laws correspond to the producing enterprises. The producers adhering to the Corporation and which forms part of the de facto corporation with the name "Ompania de Salitre de Chile" must declare in the deed of adherence that they recognize the debts contracted by said Company in the proportion corresponding to them in accordance with the provisions of the present law. The law provides for no stockholders of the petitioner, but article 7 lodges the "administration" of the corporation in the hands of a board of directors of eleven members, five selected to represent the Chilean Government, five designated by the industrialists, and the eleventh a Chilean and president of the corporation, elected by the vote of eight directors. Under article 9 the petitioner is obligated to purchase from the "adhering" producers the amounts which such producers are entitled to sell in accordance with the determination of*1343 the board of directors as provided in article 12. The directors fix annually the prices of nitrate and iodine on the basis of their industrial costs free alongside ship. The industrial cost is determined by the directors annually for each producer and *397 $1.50 per metric ton is added to such cost as a part of the price, but in no case may the petitioner fix or pay as the price of acquisition more than the sale price. Article 11 provides that the selling price shall be fixed by the directors, but it must insure a sufficient margin to service the bonds under consideration. Market conditions, however, may force a lower selling price. If the directors fail to agree on such price, the fiscal directors and the president fix its amount. The directors may cancel, reduce, or suspend the quotas of producers which do not deliver their full amounts thereof. Article 17 requires the adhering producers to deliver their respective quotas of nitrate and iodine to the petitioner under certain conditions prescribed by the petitioner and to abstain from exporting nitrate or iodine. Violators of this rule are subject to fine. Article 18 governs the current profits and their distribution. *1344 Twenty-five percent of the profits shall be paid to the Chilean Government as the price of the monopoly described in article 1. The producers receive the remaining 75 percent for distribution under prescribed priorities. First, the interest and amortization on the American and English issues of Cosach 7 percent bonds shall be paid. Then, 30 percent of the excess, if any, shall be devoted to "extraordinary amortization" of those bonds and the remaining 70 percent shall go to the producers, but profits from nitrate stocks on hand July 1, 1933, are not affected by this provision. Article 19 exempts the petitioner from income, export duty, handling and sales taxes, and any other tax relating to its "reciprocal obligations" under the law. Article 24 requires the petitioner to assume for the account of the producers the service of the so-called prior secured bonds for holders who shall conform to the provisions of Law 5350 and shall renounce their rights to overdue interest and amortization. The profits charged with the payment of the bonds are restricted to those derived from nitrate and iodine extracted from grounds inscribed on January 2, 1933, in the name of any of the adhering*1345 companies. The petitioner is authorized to contract with the trustees relating to the service and conditions of the Cosach bonds. The petitioner is required to issue bonds totaling $3,000,000 in cancellation of loans made through Anglo-Chilena for the combined operations of that company, Cosach, and Lautaro from December 1931 to March 1932. If the petitioner should be dissolved before the cancellation of the bonds mentioned in article 24, such bonds are to become a charge on Cosach in liquidation, Anglo-Chilena, and Lautaro or their successors and those companies are required to be parties to the contracts between the petitioner and the trustees, binding themselves and extending the guarantees necessary for the service of the bonds. *398 The petitioner is prohibited from issuing or servicing any bonds other than those indicated in article 24. That article also contains the provision that "these obligations shall be considered part of any transfer which may be made of lands and oficinas subject to such payment, annotations being made in the margin of the inscription and in the corresponding Register of Mortgages." Article 26 requires the petitioner to pay to the Central*1346 Bank of Chile the obligations of Cosach, Anglo-Chilena, and Lautaro to that bank and the proceeds of the nitrate stocks are to be applied to such payments. Anglo-Chilena, Lautaro, and Antofagasta "adhered" to the petitioner in January and February 1934, pursuant to article 40, Law 5350, and the petitioner forthwith was vested with the monopoly referred to in article 1 of Law 5350, by Decree No. 227, dated January 24, 1934, and proceeded to carry on business as from July 1, 1933, pursuant to article 5 of Law 5350. On October 31, 1934, the petitioner executed a trust indenture, as of December 31, 1933, to the Guaranty Trust Co. of New York, as the American trustee. Cosach, in liquidation, Anglo-Chilena, Lautaro, Antofagasta, and Glyn, Mills & Co., the British trustee, joined in the document. The indenture recited that Cosach had issued its prior secured 7 percent bonds with $35,036,000 thereof outstanding and its prior secured 7 percent sterling bonds with Pound 2,726,100 outstanding; that Cosach had been dissolved; that all the nitrate lands and plants of Cosach were being inscribed in the name of Antofagasta as Cosach's successor; that Law 5350 provided that the petitioner*1347 should assume, for the account of the adherent producers, only the service of such bonds whose owners conformed to the requirements of that law; that the petitioner should issue bonds, $3,000,000 in amount, in cancellaction of certain loans represented by bonds already issued in temporary form; that the petitioner had authorized the issuance of its 5 percent income debentures with interest payable only if and to the extent that the portion of the petitioner's consolidated net earnings, available for the service of the debentures, should be sufficient therefor; that $38,036,000 of such bonds were called dollar debentures and Pound 2,726,100 thereof were called sterling debentures (also referred to as the American issue of income debentures and the English issue of income debentures, respectively); that Cosach in liquidation, Anglo-Chilena, Lautaro, and Antofagasta had joined as parties to the indenture for the purpose of assuming unconditional liability for the payment of the principal of and the premiums and interest on the dollar debentures upon their maturity or upon the dissolution of the petitioner, and that the interest and amortization of the income debentures were to be paid*1348 preferentially *399 out of the petitioner's profits. The indenture set forth the form of the debenture in which the petitioner's promise to pay was limited in the following language: * * * provided, however, that, anything contained in this Debenture or in said Trust Indenture to the contrary notwithstanding, the Company shall be under no obligation to make any payment on account of the principal of or the premium (if any) or interest on this Debenture except out of the abovementioned proportion of the Company's consolidated net earnings available for Debenture service, as so defined and as so ascertained and determined. The indenture then authorized and provided for the issuance of the bonds so described, under certain covenants and agreements. Dollar debentures, aggregating $38,036,000, duly authenticated were to be delivered to the holders of Cosach 7 percent bonds and the petitioner's temporary debentures in exchange for such securities, which thereupon were to be canceled. The petitioner covenanted to pay the principal of and the premiums (if any) and interest on the dollar debentures only to the extent that the prescribed division of profits should permit. A similar*1349 covenant applied to the payment of the debentures at maturity and upon default. Both covenants were in accord with the limitations established in articles 18 and 24 of Law 5350. The indenture further provided that the petitioner might redeem the debentures in whole or in part upon the payment of specified premiums. The petitioner agreed to keep an office in New York City for service of notice, etc., relating to outstanding bonds, but in default thereof service could be had on the American trustee. No such office was maintained. Upon the dissolution of the petitioner or default of the bonds at maturity Cosach, Anglo-Chilena, Lautaro, and Antofagasta were required to assume the payment of the principal, premium, and interest thereof absolutely and unconditionally and not contingent upon their earnings individually or collectively. These obligations shall become a charge on the nitrate and iodine lands. The trust indenture was subject to construction by the state and Federal courts of New York and the petitioner and the adhering companies submitted to such jurisdiction. The indenture also permitted the petitioner to purchase dollar debentures on the open market, provided*1350 sufficient redemption fund moneys were in the hands of the American trustee, and to obtain reimbursement for their cost from the American trustee upon the delivery of the bonds and an appropriate certificate as prescribed by the indenture. Pursuant to the trust indenture of October 31, 1934, the petitioner issued in Chile, in replacement of the American issue of Cosach 7 percent bonds of such Cosach bondholders as wished to meke the *400 exchange, petitioner's sinking fund 5 percent income debentures. By June 30, 1935, the equivalent of $37,487,000 aggregate principal amount of the American issue of income debentures of petitioner had been issued. The holders of $492,000 principal amount of the American issue of Cosach 7 percent bonds had brought suit in Chile to secure the validation of those bonds, which suit was still pending throughout the petitioner's fiscal year 1935. Similarly, by June 30, 1935, most of the English issue of income debentures of petitioner, authorized thorized in the amount of Pound 2,726,100, had been issued. Aside from the agreements embodied in the exhibits submitted with the stipulation, the petitioner made no other agreement concerning its*1351 obligations, if any, to the holders of the American issue of Cosach 7 percent bonds or the American issue of petitioner's 5 percent income debentures. The petitioner entered neither the American nor the British issue of its debentures upon its balance sheets as liabilities, nor did it record the value of the nitrate and iodine monopoly as an asset on its books or balance sheets. For the fiscal years ended June 30, 1934, and June 30, 1935, the petitioner realized profits of Pound 1,286,252.1.8 sterling and Pound 2,153,756.8.10 sterling, respectively, and allocated to the Chilean Government 25 percent thereof, or Pound 321,563.0.6 sterling in 1934, and Pound 538,439.2.2 sterling in 1935. In the latter year the sum of Pound 625,174.12.0 sterling was distributed for the ordinary servicing of the debentures and Pound 55,855.11.2 sterling for "extraordinary amortization." The assets of the petitioner consisted chiefly of nitrate and iodine stocks, bags, accounts receivable, deposits with trustees, and cash. The principal items of its liabilities were debenture service charges, amounts due to guaranteed creditors and for matured obligations, producers' accounts, accounts payable, *1352 and intercompany balances. The petitioner's balance sheets for the fiscal year ended June 30, 1934, also reflected the purchase of its debentures for amortization and the deposits made for that purpose. The balance sheets showed no surplus and no amounts representing stock or other such capital liabilities. The total assets and liabilities of the petitioner, appearing on its balance sheets, for the fiscal year ended in 1934 were Pound 11,902,223.4.5 sterling, and for the year ended in 1935, Pound 11,320,737.15.8 sterling. The total amount of the American issue of the petitioner's debenture bonds outstanding during its fiscal year ending in 1935 was over $36,000,000. During its fiscal year ended June 30, 1935, the petitioner purchased in the United States certain of its 5 percent income debentures, of the principal amount of $189,000, for $102,881.25. The petitioner delivered these debentures to the Guaranty Trust Co. of New York, *401 its American trustee, and the trustee thereupon reimbursed the petitioner the cost thereof and canceled the debentures so purchased. The Commissioner determined that the difference between these sums, or $86,118.75, constituted income*1353 to the petitioner from sources within the United States and asserted a deficiency of $8,844.10 in income tax thereon. The petitioner paid a flat price for the debentures with no separate amount stated as accrued interest. The amount of accrued interest on such debentures from July 1, 1934, to the date of uprchase was $4,271.75. The amount of interest on the outstanding American issue of the petitioner's debentures accrued for its taxable fiscal year and paid therein was $1,836,325. OPINION. VAN FOSSAN: The basic issue in the case at bar is whether or not the petitioner realized a gain or profit from the purchase of its own debentures at less than their face value. A negative decision of this question would automatically dispose of the case. The petitioner contends primarily that it realized no income because it did not gain by the entire transaction, but only paid to debenture holders a part of its earnings. It fortifies its contention by three arguments: 1. The petitioner received no money or property upon the issue of its 5 percent debentures and hence the retirement of the debentures at a discount produced no gain. 2. The purchase of the debentures at a discount*1354 freed no assets because the petitioner's liability for payment was limited and conditioned. 3. The petitioner was insolvent both before and after the purchase. Thus no gain was realized. If the petitioner's primary contention should not be sustained, it argues further that its income should not be taxed since it was not derived from sources within the United States and that the interest it paid on its American issue of debentures should be allowed as a deduction from any income realized by it from the purchase of its debentures at a discount. The respondent controverts all of the petitioner's contentions. The detailed historical facts and circumstances relating to the formation of the petitioner and to the specific issue of this case are set forth in our findings of fact. The facts essential to an understanding of the issue may be briefly summarized as follows: On January 2, 1933, by presidential decree, Cosach was ordered liquidated. A liquidating commission proceeded to liquidate its affairs by returning the Lautaro and Anglo-Chilena stock to their former owners and by transferring the nitrate lands and plants to *402 Antofagasta. The only remaining assets*1355 of Cosach were stocks of nitrate and iodine on hand. Their value was offset by Cosach obligations equal to or exceeding it. The petitioner was organized January 8, 1934, under Law 5350, whose peculiar features will be discussed later. Pursuant to that law a monopoly of the exportation of and trade in nitrate and iodine was granted to the petitioner, and the liquidating commissioner transferred the Cosach stocks of nitrate and iodine on hand to the petitioner, which assumed the obligations above mentioned. Law 5350 also required the petitioner to assume the service and amortization of Cosach 7 percent bonds for the account of the producers, but only of those bonds whose holders accepted the modifications established by the law and by future contracts with the trustees. On October 31, 1934, the petitioner executed a trust indenture (a "future contract" contemplated by article 24 of Law 5350) securing its 5 percent debentures, to be exchanged for the Cosach 7 percent bonds and the temporary debentures. The terms of the indenture conformed to the limitations contained in Law 5350. The indenture permitted the petitioner to purchase its own 5 percent debentures out of a redemption*1356 fund authorized by that instrument. The 5 percent debentures were issued and all but $492,000 thereof were exchanged for Cosach 7 percent bonds. During the taxable year the petitioner purchased its 5 percent debentures of the par value of $189,000 for $102,881.25 and was reimbursed therefor by the trustee out of the redemption fund. The facts of the case at bar are unusual in many respects. Although the obligations purchased by the petitioner have been denominated "debentures" and are regarded as bonds, they possess peculiar features which, as to the petitioner, may impute a relationship wholly unlike that of the obligor of an instrument customarily considered a bond or indenture. In the promissory clause of the debenture the petitioner promises to pay to the bearer or registered owner the principal sum of $1,000 and interest thereon at 5 percent. However, this promise is conditioned and limited later in the document to the proportion of the petitioner's consolidated net earnings available for debenture service, as defined in Law 5350. Thus the petitioner is under no obligation whatever to pay either the interest or the principal unless it has net earnings sufficient for*1357 that purpose. But the "adhering" companies are charged with the unconditional liability for such payment, upon default of the petitioner, its dissolution or the maturity of the debentures. Therefore, those companies are virtually the primary obligors of the debentures as to both principal and interest. The obligation may be regarded as a joint and several one assumed *403 by the petitioner and the adhering companies but greatly restricted the precise amount of the petitioner's liability to pay the principal the precise amount of the petitioner's yet the liability was real and and interest of its debentures, yet the liability was real and monetarily measurable. So also the monopoly granted by the Government of Chile was of great value. While the 25 percent of the net consolidated earnings was fixed as the current price of its enjoyment, it does not follow that it had no capital value. Many intangibles such as good will, contractual rights, equitable interests, etc., are valuable assets and are includible in their owner's financial statements. The omission of both of these items, the debentures and the monopoly, from the petitioner's balance sheets does not prove their*1358 nonexistence. They should have been included therein in order to arrive at the petitioner's true net worth. In view of their exclusion we can not say that the petitioner had no assets other than current stocks, etc., nor that it was insolvent. The character of the petitioner itself is also anomalous. It was created as a selling agency for the producers, to control the production and to secure the sale of nitrate and iodine, to provide revenue for the Government, and to establish an orderly and healthy condition of the industry. Although given a corporate form and entity by Law 5350, it had no stockholders as such. No provision was made for the distribution of its assets upon liquidation. If we should assume that the net liquidated assets, if any, would follow the 25-75 percent division of its net earnings, we would doubtless be met with the argument of the producers that the 25 percent was payable to the Chilean Government for nitrate and iodine currently produced and that, therefore, they would be entitled to any enhancement of capital value. But, regardless of the manner of the ultimate adjustment of that problem, it is obvious that the producers are the principal beneficiaries*1359 of the petitioner's profits. For practical purposes they correspond to stockholders of the petitioner corporation. The petitioner was engaged in a highly profitable business. While its structure prevented its own enjoyment of its gains, yet they inured to the ultimate benefit of the adhering companies which used the petitioner as a means of deriving profit from the production of the commodities. Therefore, any tax upon the petitioner will fall upon the adhering companies where it properly belongs. With these facts in mind we may proceed to a discussion of the petitioner's contentions. It first argues that it received no money or property upon the issuance of its 5 percent debentures, and hence received no gain upon the retirement of such debentures at a discount. We do not agree. *404 Cosach had been organized by Law 4863. It had issued its 7 percent bonds by authority of that law. It acquired the stock of the large competing companies and the assets, including nitrate lands, of some thirty smaller companies. It thus obtained control of practically the entire nitrate producing industry in Chile. In the early part of 1932 it needed additional working capital. *1360 Shortly thereafter it defaulted in its bond obligations. In January 1933 the president of Chile held that Cosach had been illegally organized and operated and ordered its liquidation. Law 5133 created a liquidating commission which took charge of Cosach's affairs. The commission proceeded to perform its duties. In contemplation of the situation thus outlined, Law 5350 was enacted to restore the nitrate industry to a firm foundation. That law required the petitioner to assume certain debts of Cosach and the stocks of nitrate and iodine were transferred to the petitioner. The law also required the petitioner to assume "for the account of the producers" the service of Cosach 7 percent bonds and granted the monopoly heretofore described. Although the consummation of the various steps required to carry out these details occupied some time, such steps were all parts of the same reorganization plan. The petitioner maintains that it received neither money nor property upon the issuance of its debentures. The petitioner seems to regard the issuance of its debentures as a gratuitous act based on no valuable consideration. In our opinion that view of the matter is in error. *1361 The petitioner was required to assume Cosach's liability on its bonds as a contemporaneous condition of its enjoying the government monopoly. Its own bonds were merely a substitution for the Cosach bonds, but they imposed a charge of only 5 percent as against the 7 percent payable formerly. Thus the petitioner was in a better financial position after the issuance of the debentures than before and had received a valuable right in addition to those acquired directly under Law 5350. The petitioner further argues that no assets were freed from a liability to which they were theretofore subject. By the purchase under discussion the petitioner needed $86,118.75 less to extinguish its $189,000 worth of debentures than it would have required if they had been allowed to mature. To that extent, therefore, its other assets, including earnings from operations, were freed to contribute to the promotion of sales, the circulation of propaganda, and other activities which in turn would result in increased profits, all redounding to the benefit and advantage of the petitioner and, through it, of the producers. The petitioner next maintains that it was at all times insolvent. This argument*1362 has been considered in the previous general discussion. *405 We need only to repeat that the petitioner has not proved that it was or is insolvent. The facts before us indicate quite the contrary. If the petitioner's position were correct we would behold this incongruous spectacle: Active and prosperous companies, owning practically all of Chile's nitrate and iodine producing lands worth millions of dollars; enjoying through the petitioner a monopoly in their industry; making a handsome yearly profit (over $5,000,000 in 1934 and over $9,000,000 in 1935), enough in fact to enable them to reduce their outstanding obligations by many thousands of dollars; and yet entrusting their entire sales and collections therefrom, aggregating about $20,000,000, to a hopelessly insolvent concern. We can follow neither the petitioner's reasoning nor its assumptions of fact in this respect. Since we have decided adversely to the petitioner in its major contention, we must now consider its second point. The petitioner asserts that the income, if any, is not taxable, since it was derived from sources without the United States. *1363 Petitioner argues that section 119(a) of the Revenue Act of 1934 1 specifies those classes of income which shall be treated as arising from sources within the United States and that, since the gain in question does not fall in any of those classes, it is not taxable. We considered this argument in Zander & Cia, Ltd.,42 B.T.A. 50, and there held that the statute intended no exclusive enumeration of the types of taxable income from sources within the United States and that income primarily originating in this country is to be taxed without reference to the enumeration. Hubert De Stuers,26 B.T.A. 201; Carding Gill Ltd.,38 B.T.A. 669; and see Helvering v. Suffolk Co., Ltd., 104 Fed.(2d) 505. *1364 The petitioner further renews its contentions that it received no consideration for the original issuance of its debentures and that the *406 purchase thereof freed no assets. However, assuming that both points should be decided adversely (as they are), it argues that the Commissioner should have promulgated a regulation specifically applicable to the type of income here involved and that, in the absence of such a regulation, the income can not properly be regarded as income from United States sources. In Carding Gill Ltd., supra, we observed that the petitioner overlooked looked the provisions of section 119(e) of the Revenue Act of 1934, 2 and said: It is true the statute contains no express reference to personal propery both purchased and sold within the United States. Gains therefrom, however, are obviously items of gross income, and are consequently to be treated, under specific legislative direction, by regulation. * * * The applicable provision of Regulation 74 makes the place of sale the test; and it is conceded on petitioner's brief that the securities involved were sold in the United States. * * * *1365 The transaction which the respondent asserts gives rise to income was the petitioner's purchase of its own debentures. Their original value in the United States was no less than par. The debentures were exchanged for Cosach bonds in the United States and delivered here. The purchase was made in the United States from holders of the bonds in this country. The trustee was a New York trust company and provision was made in the trust indenture for service of notice in the United States. The trustee also canceled the debentures in the United States. *407 In the face of these facts it is obvious that the petitioner's contention can not be sustained. We find no statutory exemption anywhere excluding from income gain derived from the petitioner's purchase of its own debentures. (See I.T. 3119, 1937-2, C.B. 227.) Therefore, the familiar principles established in the Kirby Lumber Co. case (United States v. Kirby Lumber Co.,284 U.S. 1) control the taxation of the gain. See also Helvering v. American Chicle Co.,291 U.S. 426, in which the bonds were those of a predecessor and had been assumed by the taxpayer. *1366 B. F. Avery & Sons, Inc.,26 B.T.A. 1393; Montana, Wyoming & Southern Railroad Co.,31 B.T.A. 62. The petitioner's final contention is that the interest accrued and paid by it on its American issue of debentures should be allowed as a deduction from any income realized by it from sources within the United States through its purchase of its American debentures. The statute governing the deduction is section 232 of the Revenue Act of 1934. 3 It limits the deductions allowed to a foreign corporation to those "connected" with income from sources within the United States. The income in the case at bar from such a source is the gain derived from the petitioner's purchase of its own debentures at a discount. That was the only transaction consummated during the taxable year by the petitioner in this country. *1367 Funk & Wagnalls New Standard Dictionary defines the word "connect" as meaning: (1) To join together as by links or fastenings; unite or combine in any way; bring into correlation; associate. (2) To unite or join; be in close relation; be associated. I.T. 2792, XIII-1, C.B. 85, states: * * * To be allowable, therefore, the deduction must be "connected" with income from sources within the United States. The word "connected" means "joined or linked together by some tie, as of causality, relationship, or intimacy." The meaning at once suggested is that the requisite tie between the deduction and the income is that of causality, that is, that the expenditure for which the deduction is claimed must enter into, and be directly related to, the production of the income. The purchase under discussion was an isolated transaction unassociated with the payment or accrual of current interest charges. The payment of interest was required by the trust indenture and had to be made in any event. It bore no relation to the purchase and did not contribute to the realization of the petitioner's income. The *408 interest accrued by the petitioner was not "connected" with or related*1368 to the purchase of the debentures and hence is not deductible. The position which we took in Royal Insurance Co., Ltd.,38 B.T.A. 955, is not in conflict with our conclusion here. In that case we held that the limitation section 232 and its predecessors applied not only to depreciation, amortization, and depletion, but also to other deductions, such as losses, which were actually "connected with income arising from a source within the United States." The reference to the legislative history there made is also appropriate to the situation here. The Report of the Senate Finance Committee relating to the Revenue Act of 1918 states (p. 8): In the case of nonresident alien individuals and foreign corporations, expenses, losses, debts, depreciation, amortization, and depletion are, under the language of the House bill, allowed only to the extent that they are connected with a trade or business carried on within the United States, and the depreciation, amortization, and depletion deductions are allowed only with respect to property within the United States. In many cases, however, property outside of the United States is directly concerned in the production of income*1369 taxable in the United States. Accordingly, the limitation with respect to nonresident aliens and foreign corporations has been modified so that the specified deductions shall be allowed to the extent that they are connected with income arising from a source within the United States (sec. 214(b) and sec. 234(b)). [Emphasis supplied.] Thus, in view of our decision that the interest was not connected with the purchase, the amount of the interest is not deductible within the purview of the statute. Cf. Stockholm Enskilda Bank,40 B.T.A. 107. Decision will be entered for the respondent. Footnotes 1. SEC. 119. INCOME FROM SOURCES WITHIN UNITED STATES. (a) GROSS INCOME FROM SOURCES IN UNITED STATES. - The following items of gross income shall be treated as income from sources within the United States: (1) INTEREST. - Interest from the United States, any Territory, any political subdivision of a Territory, or the District of Columbia, and interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, not including - * * * (2) DIVIDENDS. - The amount received as dividens - (a) from a domestic corporation * * * (b) from a foreign corporation * * * (3) PERSONAL SERVICES. - Compensation for labor or personal services performed in the United States; (4) RENTALS AND ROYALTIES. - Rentals or royalties from property located in the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using in the United States, patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like property; and (5) SALE OF REAL PROPERTY. - Gains, profits, and income from the sale of real property located in the United States. (6) SALE OF PERSONAL PROPERTY. - For gains, profits, and income from the sale of personal property, see subsection (e). ↩ 2. (e) INCOME FROM SOURCES PARTLY WITHIN AND PARTLY WITHOUT UNITED STATES. - Items of gross income, expenses, losses and deductions, other than those specified in subsections (a) and (c) of this section, shall be allocated or apportioned to sources within or without the United States, under rules and regulations prescribed by the Commissioner with the approval of the Secretary. Where items of gross income are separately allocated to sources within the United States, there shall be deducted (for the purpose of computing the net income therefrom) the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of other expenses, losses or other deductions which can not definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the United States. In the case of gross income derived from sources partly within and partly without the United States, the net income may first be computed by deducting the expenses, losses, or other deductions apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which can not definitely be allocated to some items or class of gross income; and the portion of such net income attributable to sources within the United States may be determined by processes or formulas of general apportionment prescribed by the Commissioner with the approval of the Secretary. Gains, profits, and income from - (1) transportation or other services rendered partly within and partly without the United States, or (2) from the sale of personal property produced (in whole or in part) by the taxpayer within and sold without the United States, or produced (in whole or in part) by the taxpayer without and sold within the United States, shall be treated as derived partly from sources within and partly from sources without the United States. Gains, profits and income derived from the purchase of personal property within and its sale without the United States or from the purchase ofpersonal property without and its sale within the United States, shall be treated as derived entirely from sources within the country in which sold, except that gains, profits, and income derived from the purchase of personal property within the United States and its sale within a possession of the United States or from the purchase of personal property within a possession of the United States and its sale within the United States shall be treated as derived partly from sources within and partly from sources without the United states. ↩ 3. SEC. 232. DEDUCTIONS. In the case of a foreign corporation the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States; and the proper apportionment and allocation of the deductions with respect to sources within and without the United States shall be determined as provided in section 119, under rules and regulations prescribed by the Commissioner with the approval of the Secretary. ↩