## Facts

- Mechanical Products, Inc. (MPI), a U.S. corporation, later merged into Aiken Industries, Inc. (Aiken), making Aiken MPI’s successor.
- MPI borrowed $2.25 million from Ecuadorian Corporation, Ltd. (ECL), a Bahamian corporation, issuing a 4% promissory note in 1963.
- In 1964, ECL transferred MPI’s note to Industrias, a Honduran corporation ultimately owned within the affiliated group.
- In exchange, Industrias issued nine demand notes to ECL totaling $2.25 million, also bearing 4% interest.
- The arrangement functioned as a back-to-back loan: MPI paid 4% interest to Industrias; Industrias paid the same 4% interest to ECL.
- Industrias had no spread, profit, or meaningful economic stake in the interest stream and was obligated to pay out what it collected.
- MPI paid interest to Industrias in 1965 and did not withhold U.S. tax, claiming exemption under Article IX of the U.S.–Honduras Income Tax Convention for interest “received” by a Honduran corporation without a U.S. permanent establishment.
- The Commissioner determined MPI/Aiken was liable for U.S. withholding tax on the interest under I.R.C. §§ 1441–1442 and asserted additions to tax under I.R.C. § 6651(a); the 1964 year was conceded as time-barred, leaving 1965.

## Issues

1. Whether the U.S.–Honduras treaty exempted the 1965 interest payments where the Honduran corporation served only to collect and remit the interest for a Bahamian corporation.
2. Whether the payor’s successor was liable for an addition to tax under I.R.C. § 6651(a)(1) for failure to file a required return related to withholding.

## Decision

- The Tax Court held the interest was not exempt under Article IX and that Aiken, as successor to MPI, was liable for withholding tax on the 1965 interest payments.
- The Tax Court disallowed the § 6651(a) addition to tax.

## Legal Principles

- Treaty relief for interest conditioned on being “received” by a treaty-country resident may be denied when the nominal payee is a conduit with no beneficial interest in the payments.
- In applying treaty provisions, the court may look to the transaction’s economic substance and whether the intermediary bears profit potential or meaningful risk, rather than accepting formal payment routing.
- For U.S.-source interest paid to foreign corporations, absent an applicable treaty exemption, withholding applies under I.R.C. §§ 1441–1442.
- Additions to tax under I.R.C. § 6651(a)(1) are not imposed where the failure to file is not shown to be due to willful neglect and the circumstances support reasonable cause.

## Conclusion

The Tax Court treated the Honduran corporation as a pass-through collector for a Bahamian lender, so the treaty’s interest exemption did not apply and withholding tax was due for 1965, but the court declined to impose the § 6651(a) failure-to-file addition to tax.


Aiken Indus., Inc. v. Comm'r, 56 T.C. 925 (1971)