Foreign Relations of the United States, 1964–1968, Volume VIII, International Monetary and Trade Policy

91. Report From the Voluntary Cooperation Program Coordinating Group to the Cabinet Committee on Balance of Payments¹

Washington, April 26, 1966.

SUBJECT

• Operating Problems under the Voluntary Cooperation Program

Since the announcement of the President’s balance-of-payments program, a small informal group has been meeting periodically in the Treasury Department to discuss operating problems arising under the voluntary cooperation program. In particular, the group has endeavored, through consultation among the agencies directly concerned, to insure a coordinated interpretation of the Commerce Department and Federal Reserve guidelines in specific cases. Following are the major issues considered since the date of the last report of the Group, November 16, 1965:²

1. Convertible Bonds Issued by U.S. Corporations in Europe

Some of the bond issues abroad by U.S. subsidiaries to replace outflows of U.S. capital carry the privilege of conversion at a later date into the stock of the parent corporation in the U.S. This convertibility privilege tends to lessen the U.S. balance-of-payments gain from U.S. subsidiaries’ issues abroad for several reasons. First, it makes such issues an attractive alternative for European investors who would otherwise have purchased U.S. corporate stocks without any new incentive. Secondly, when the conversion takes place the stock in the U.S. parent may be sold to Americans without the latter having to pay the IET.

In order to minimize these disadvantages, U.S. underwriters for these European issues were urged by Treasury to make the right-of-conversion date as late as possible, and no sooner than the scheduled expiration date of the IET, July 31, 1967. Also, the Group supported the Commerce Department’s guideline instruction that the U.S. parent company take a debit in the calculation of its program progress for the amount of any conversions when they occur.

2. Problems Relating to the Balance-of-Payments Program As Applied to Canada

A considerable amount of time was spent on problems related to Canada. The large amounts of Canadian new bond issues being floated in the U.S. market in the fall of 1965 were accompanied by a build-up in Canadian reserves. Consideration was given by the Group to the extension of the guidelines on purchases of long-term securities by nonbanking financial institutions to cover securities of ten years or more maturity. Since these institutions are the primary buyers of long-term Canadian securities this would have put Canadian issues under control.

The Canadian response to this proposed action was an agreement early in December, 1965 whereby Canada would in 1966 reduce its reserves to a level slightly below that of July, 1963 ($2.7 billion). The Canadian Government would be prepared to buy its own outstanding obligations owned in the United States in order to meet its reserve target. (Such purchases were made in the amount of $44 million in January.) The U.S., in turn, was to continue to permit unlimited access in the U.S. market to new Canadian long-term security issues. The Canadian authorities also agreed to sell $200 million of gold to the U.S. in 1966.

Purchases by Canadian insurance companies, either directly or through their U.S. branches, of U.S. “Delaware subsidiary” issues designed to be sold abroad was another problem. Canadian companies were financing these purchases in part by selling off some existing holdings of U.S. securities, thereby negating the favorable balance-of-payments impact for which the offshore securities were designed. Also, there was that much less for purchase by European investors who would furnish a desirable market for such issues from a U.S. balance-of-payments viewpoint. The U.S. informally requested the Canadian authorities to urge their insurance companies to refrain from further purchases of these securities.

The Canadian response, after discussions early in March, was a guideline issued by the Canadian Government to all Canadian investors asking them not to acquire securities denominated in Canadian or U.S. dollars which are issued by U.S. corporations or their non-Canadian subsidiaries and which are “subject to the U.S. interest equalization tax if purchased by U.S. residents.”

Long-term security issues in Canada by foreigners other than Americans were considered to have a negative impact on the U.S. balance of payments since such borrowings in effect constitute a “pass through” of U.S. funds through Canada to third countries.

The Bank of Canada and the Government have been discouraging such third-country issues in Canada. The Canadian Minister of Finance has stated such issues will continue to be discouraged since they increase pressure on the Canadian capital market and lead to increased borrowing in the United States by Canadians.

The Canadian Government conferred with the U.S. Government on a draft of some guiding principles for good corporate behavior for Canadian subsidiaries of foreign companies. This draft was reviewed from the viewpoint of possible conflict with the VCP and appropriate comments were forwarded to the Canadian Government which released the guiding principles under a statement by the Minister of Trade and Commerce on March 31, 1966.³

3. Question of Borrowing in United States by Developed Countries for Reinvestment in U.S. or in Less Developed Countries

The Group considered several proposed borrowings in the U.S. as regards their consistency with the VCP guidelines. One type involves borrowing in the U.S. for investment in the LDC by an “LDC corporation” which is a subsidiary of a corporation in a developed country. The other involves borrowing in the U.S. for investment in the U.S. by such a subsidiary.

The first type of borrowing qualifies for the LDC exemption under the IET unless the borrowing firm was availed of primarily for making a transaction which the U.S. lender could not have made directly without paying the IET.

The second type of borrowing is, as a rule, subject to the IET.

As regards the Federal Reserve guidelines for nonbank institutions which are the major investors in such cases, they do not place any ceiling on credits of over ten years maturity extended to less developed countries. Credits to developed countries other than Canada and Japan are subject to a percentage ceiling (zero in the case of Europe) under the nonbank guidelines, without reference as to whether the proceeds are to be used abroad or in the U.S. The guidelines also ask institutions to refrain from making loans to U.S.-based subsidiaries and branches of foreign companies which would substitute for funds normally obtained from foreign sources.

The Coordinating Group considered a specific case of a proposed borrowing by an LDC subsidiary last year. The borrowing by an LDC subsidiary of ENI, the Italian oil company, was to be guaranteed by ENI, with the proceeds being used in the LDC. After discussion by the Group, the Italian Government was informed that such a borrowing, with a parent guarantee, would be inconsistent with our program.

A case of the second type of borrowing arose in the Fund of Funds case. The Fund of Funds wanted an exemption in the IET legislation for borrowing in the U.S. where the proceeds were to be reinvested in the U.S. This was opposed on the grounds that such an exemption would have to apply to any borrowing in the U.S., where the stated purpose was for reinvestment in the U.S. It would not be feasible to assure that such investment did not merely replace investment of foreign funds in the U.S., or that an equivalent amount of foreign capital already invested here might not later be withdrawn.

The latest case involved a borrowing in the U.S. by an “LDC subsidiary” of a U.K. corporation, with the subsidiary transferring the entire proceeds of the borrowing to a U.S.-based British subsidiary. The latter, in turn, was to invest the proceeds in a printing firm in the U.S. While this particular borrowing arrangement would probably have been exempt from the IET only by virtue of a special exemption which was written into the IET legislation for another purpose, a restructuring of the transaction clearly would have made it possible to avoid the tax.

The prospective U.S. lender, an insurance company, requested a ruling that the Federal Reserve guidelines did not apply, on the grounds that the loan was essentially a domestic loan. It was claimed that U.K. exchange controls and the high premium which the U.S. parent corporation would have had to pay to acquire investment dollars in the U.K. effectively precluded the possibility of an inflow of U.K. funds into the U.S.

Treasury opposed a ruling that this was not a foreign loan, whereas the Federal Reserve had so ruled and had informed the underwriters.

The following points were made:

The Fed maintained that if there is good reason to believe that the investment in the U.S. would not or could not be made from foreign capital, there was no reason to interfere with the use of U.S. capital.

Also, the Fed believed it would not be consistent or fair for the U.S. to discourage or deny European borrowings in the U.S. for investment in the U.S. when we were encouraging U.S. firms to borrow abroad for financing foreign investment.

Finally, the Fed pointed out that, unlike previous cases considered, the loan agreement in this case made it impossible for the invested funds to be repatriated for at least five years.

Treasury maintained that while there might be a strong presumption of no balance-of-payments loss in a particular case, a precedent would be set for cases where the question was more debatable. Also, there was no assurance that an equivalent amount of existing U.K. investment in the U.S. would not be liquidated.

With regard to encouraging our firms to borrow in Europe, Treasury pointed out that such borrowings are allowed by only a few of the European countries (not including the U.K.). Furthermore, such U.S. borrowing abroad is generally accompanied by large inflows of U.S. capital, whereas foreign borrowing here for investment in the U.S. is rarely accompanied by much inflow of foreign capital. Finally, to allow borrowing in the U.S. for investment here by corporations of developed countries, thus possibly releasing their other sources of funds for use elsewhere, at a time when we are restricting foreign investment by U.S. corporations, would tend to undermine cooperation under the voluntary program.

4. Proposed Exemption from IET for Foreign Branch Dollar Loans

When the IET was made applicable to the banks on February 10, 1965 it was felt that to exempt the loans of foreign branches would leave the possibility of evasion of the IET by the parent banks, either through a direct transfer of funds from the parent to the branch for lending to foreigners or by the parent steering its depositors away from itself to its branches abroad. However, in recognition of the facts that foreign branches had to compete with foreign-owned banks which are not subject to the IET and that non-U.S. residents were the main source of foreign currency deposits of the branches, foreign currency loans by branches were exempted from the IET.

The banks have requested similar treatment for dollar term loans by their branches abroad. They make this case primarily on the basis that there has been a change in conditions both as they affect the branch banks’ competitive position and the U.S. balance of payments.

As a result of the voluntary cooperation program, corporations are now financing more of their foreign operations from foreign sources. To a great extent they are raising these funds through bond issues in Europe. However, they cannot meet their financing needs entirely through this source since the capacity of the European bond markets is limited and because bond issues are not an appropriate method for all types of financing. The other changed condition is the Federal Reserve guideline for commercial banks which applies to the latters’ loans to their foreign branches as well as to other foreigners.

The banks argue that because of the increased demand for dollar term loans by U.S. subsidiaries abroad, foreign branches of U.S. banks are finding the tax a competitive handicap. Rather than pay the tax, U.S. subs may seek loans from foreign-owned banks or look to the U.S. for funds, thus tending to increase dollar outflows from the U.S. To cope with this situation, some U.S. branch banks abroad have made loans to the U.S. parent manufacturing company which then transfers the funds to its foreign subsidiary.

The banks maintain that to the extent loans can be made by their branches abroad, the pressure on the head office for foreign loans is reduced. They contend that the ability to make long-term loans would be an important incentive to their branches to induce depositors to lengthen the maturities of their deposits, thus tending to reduce the flow of dollars into central banks and their possible conversion into gold. Finally, they believe that their branches’ ability to make tax free dollar term loans would not attract a private capital outflow from the U.S. Several banks stated it was their policy not to have their overseas branches accept transfers of deposits from U.S. residents.

The Coordinating Group concluded that the banks’ position was reasonable and the Treasury will request legislation to exempt from the IET dollar term loans by foreign branches of U.S. banks.

In case such exemption should have the effect of attracting dollar deposits from the U.S., a legislative provision will be requested giving the President the authority to reimpose the IET on dollar loans if necessary.

5. Exemption of Bank Loans to Canada from IET

When the Executive Order was issued September 5, 1964, exempting new issues of stock or debt obligations by Canadians from the Interest Equalization Tax, bank loans were not subject to the Tax.⁴

In February, 1965, when medium-and long-term bank loans were made subject to the IET, we did not recommend an exemption for such loans to Canada. They had historically been relatively unimportant and it seemed advisable to keep exemptions to the minimum.

In recent months, however, some U.S. banks have emphasized that there is no logical justification for a difference in the treatment under the IET of loans with maturities of one year or more made by banks compared with those of nonbank lenders.

Given the financial understanding we have with the Canadians and the fact that bank loans to Canada would be counted against the Fed ceiling, action along these lines did not seem likely to have any serious balance-of-payments effects. Any increase in bank lending to Canada—not likely to be large in any case—could lessen Canadian demands on our capital market in other forms.

For reasons of equity, therefore, the Group agreed to recommend to the President that he issue an Executive Order amending the Canadian exemption to the Interest Equalization Tax to provide for inclusion of bank loans with maturity of one year or more within the terms of the exemption.

1. Source: Department of State, Ball Papers: Lot 74 D 272, Balance of Payments. Limited Official Use. In a May 2 covering memorandum to the Cabinet Committee on Balance of Payments, Assistant Secretary of the Treasury for International Affairs Trued identified the report as the third report of this interagency coordinating group. A copy was also sent to Martin, Chairman of the Federal Reserve System.
2. A copy of the undated report was transmitted under cover of a November 16 memorandum from Trued to the Cabinet Committee on Balance of Payments. (Johnson Library, National Security File, Subject File, Balance of Payments, Vol. 3 [2 of 2], Box 2.
3. This statement has not been found.
4. Regarding Executive Order 11175, see Document 12.