Taxation of Cuban Confiscated Assets After Restitution

Taxation of Cuban Confiscated Assets After Restitution***
2006-10-05
Timothy Ashby, JD, PhD* and Tania Mastrapa, PhD**

The Castro regime’s confiscation was the largest seizure of U.S.
property in history, greater than the value of American assets taken by
all other Communist governments combined.(1)

Expropriated U.S. assets included 90% of all electricity generated in
Cuba, the entire telephone system, most of the mining industry, and
between 1.5 and 2 million acres of land.(2)Promised compensation for the
properties never materialized. As a result, a number of U.S. corporate
and individual taxpayers took deductions for these losses on their
income tax returns.

Claims for confiscated assets remain one of the most contentious issues
between the U.S. and Cuba, and appropriate restitution is a statutory
condition for normalizing relations with a post-Castro Cuban government.
Normalization of relations is inevitable, and U.S. claimants will
receive settlements in the form of recovery of their properties or
compensation. The tax implications of such settlements are substantial,
as estimates of the total present value of U.S. certified claims,
including 46 years of accumulated interest, range from $6 to $20 billion.(3)

A major issue is how the IRS will treat U.S. taxpayers who recover
properties or receive compensation for confiscated Cuban assets. This is
complicated by the fact that many of the one million Cuban exiles and
their legal heirs who are now U.S. taxpayers did not file claims or take
deductions for confiscated properties, yet will presumably have their
assets restored or receive various forms of compensation. While
taxpayers who recoup their properties will probably not be subject to
taxation except for the amount taken as a deduction for losses, such
claimants may be a minority. The majority may receive other forms of
compensation that will be subject to U.S. taxation.

During the process of normalizing U.S.-Cuba relations, taxpayers can
expect to receive various forms of settlements for their property
claims. Remedies will range from actual restoration of original real
estate and personal property, substitution for another property of equal
value, vouchers redeemable for substitution, future cash payments,
shares in joint ventures, privatized companies or investment funds,
bonds, or other debt instruments.

The Tax Code treats the return or recovery of property that was once the
subject of a deduction as income in the year of its recovery. When an
original property is restored to the taxpayer or his heirs, no taxable
event has occurred if no deduction was taken for the loss or any
deductions taken were not fully used. Taxpayers who took loss deductions
on recouped Cuban properties would therefore be liable only for the
amount of deductions; they would not owe any excess on their basis
despite the asset’s appreciation in value.

Several issues will make the actual restoration of original properties
complicated if not impossible. If the U.S. and Cuba reach a bilateral
compensation agreement, certified claimants (who have not already sought
a resolution to their property claims independently) will receive
payments distributed to them by the U.S. government. At that point, the
restoration of their properties is no longer an option because they will
have been compensated. In other words, the federal government would make
claimants a “take it or leave it” offer of a few cents on the dollar –
based on a 1960 valuation – with no other remedy.

From 1959 to 1963, over 85,000 new homes were built on confiscated land
in Cuba, and the Urban Reform Law gave renters ownership rights. Cubans
who received property titles to confiscated residences will probably
retain possession of these properties. A post-Castro regime may also
recognize adverse possession for social stability as well as to reduce a
deluge of restitution litigation.

Under the Tax Code, if property has been confiscated, no gain shall be
recognized if it is converted into property that is similar or related
in service or use to the property. Such conversions will probably be
recognized as non-taxable exchanges -- an exchange in which a taxpayer
is not taxed on any gain and on which any losses cannot be deducted. The
tax code considers the basis of property in a nontaxable exchange the
same as that of the property transferred. Therefore, if taxpayers have
not taken deductions for confiscated Cuban property, they will
presumably not be subject to taxation even if the substituted asset is
worth substantially more than the basis of the original property in 1960
dollars. However, if the substituted property is sold, the amount over
the basis will be included in taxable income of the restituted owner.

Monetary compensation received in lieu of confiscated property would
probably be a taxable exchange, which occurs when cash or property (e.g.
bonds or shares) is received that is not similar or related in use to
the property exchanged. The basis of the property received is usually
its Fair Market Value at the time of the exchange. If confiscated
property is converted into money or into property not similar or related
in use to the converted property, any gain is recognized to the extent
that the amount realized upon such conversion exceeds the cost of the
other property.

This would impose an inequitable burden on taxpayers if a cost basis
dating from 1960 back into the early 20th century is used, as many
residences and businesses were acquired decades (and in some cases,
centuries) before the 1959 Revolution. This is demonstrated by claims
filed by Chase Manhattan Bank. On its books Chase listed its real estate
holdings at a depreciated cost of $110,000. The last appraisal of any
Chase branches was made in March 1960, and applied only to the Havana
office. This valued the premises at $165,000, and the necessary
adjustment to bring the book value for that property to market was
stated as $54,800. Today this building is worth at least $400,000;
within a year after normalization of relations its value will probably
double.

The Tax Code allows taxpayers whose property has been converted into
money or dissimilar property to avoid taxable gains by (a) purchasing
similar property with the proceeds within two years, or (b) purchasing a
controlling interest (80% of the combined voting power of all classes of
stock and at least 80% of the total number of shares of all other
classes of stock) in a corporation owning such other property.(4) It
would be unreasonable to expect that most compensated taxpayers would be
willing or able to buy similar properties (in the U.S. or Cuba), and it
is unlikely that there would be many opportunities for even large U.S.
companies to purchase a controlling interest in corporations owning
similar Cuban properties within two years after compensation.

Another major issue that will confront taxpayers is how the IRS will
value restituted properties or compensation. Even though many industrial
assets will have lost their original economic value (e.g. sugar mills
built in the 1920s), the discrepancy between book value and FMV after
nearly half a century will be enormous in most cases. For example, in
1994, the Mexican firm Grupo Domos purchased 49 percent of EmtelCuba for
$1.5 billion which represented half of Cuba’s generally antiquated
telephone system.(5) In comparison, in 1960 ITT was allowed a claim of
$130.7 million for Cuba’s entire telephone system. The Helms-Burton
legislation contemplates that, with limited exceptions, U.S. courts will
adopt the valuations determined in awards issued by the Cuban Claims
Program. In cases where a plaintiff was not eligible to file a claim
(i.e. was not a U.S. national at the time of confiscation), the
legislation authorized U.S. District Courts to appoint the Foreign
Claims Settlement Commission as Special Master to make determinations on
such issues as ownership of property, for use in court actions.(6)

Applying half-century-old valuations to properties in a market that will
probably grow as fast as that of the East Berlin real estate sector in
the post-Communist era would be unrealistic and unfair to claimants.(7)
For example, in Havana’s upscale Miramar district, where many Cuban
exiles lived, a 31-apartment complex built in the late 1990s sold out in
weeks to foreign buyers at prices ranging from $94,000 for a studio to
$400,000 for a penthouse.

Another issue is how the IRS will treat successors in interest. Since
the 1960s, a significant number of the 78 publicly owned U.S.
corporations that suffered asset seizures in Cuba have been merged,
acquired or dissolved. Generally, the corporation surviving a statutory
merger assumes all the powers, rights, debts, and liabilities of the
corporation merged into it.

An example of the accounting and legal complexities that will be
involved in Cuban settlements is the case of Moa Bay Mining Company,
which claimed $88.3 million in confiscation losses. The company was
wholly owned by Freeport Nickel Company, a subsidiary of Freeport
Sulphur Corporation. Today Freeport is owned by a joint venture between
IMC Global Inc. – the world’s largest purchaser and user of sulphur –
and Savage Industries Inc., a major materials management and
transportation systems company. The possible compensation for Moa Bay’s
Cuban assets should be of interest to IMC and Savage, as the current
value of its confiscated nickel and cobalt mining assets is estimated at
$5-7 billion.

Some taxpayers may choose to relinquish their property claims rights or
give them to relatives or friends because they are not interested in
their properties or compensation. Taxpayers who relinquish claims may
nonetheless be liable for taxation. Generally, the IRS position is that
assigned claims or property fall under the “assignment of income”
doctrine, under which the taxpayer cannot avoid recognizing income by
assigning it to another person, unless his renunciation of the property
amounts to an abandonment of his rights without a transfer of rights to
another.

Taxpayers who give claims rights to friends or relatives as gifts are
subject to gift tax on the transfer, with the statutory annual
exclusion. The value of the gift is excluded from the recipient’s gross
income, regardless of the amount of the gift. Relinquishing the right to
the property/compensation may be interpreted as a gift to the Government
of Cuba.

U.S. taxpayers (including Cuban exiles) whose properties were taken by
the Castro regime may suffer additional victimization if they receive
compensation at present value, which in most cases would be a large
multiple of their basis in the property. Many such claimants would be
unable to pay income tax on compensation received for properties that
may now be worth millions of dollars. For example, last year a
95-year-old woman filed an action in federal court against the Club Med
hotel chain for building a luxury resort on Varadero beachfront property
confiscated from her family, which also owned prime real estate occupied
by two other foreign hotels chains.

One solution may be for the U.S. Congress to enact legislation to allow
qualifying taxpayers to exclude compensation payments from taxable
income. A precedent is the 2001 Economic Growth and Tax Relief
Reconciliation Act which allowed Holocaust survivors, their heirs or
estates to receive the full benefit of any compensation payment made by
governments or industry by excluding from income taxes compensation
payments. Cuban exiles (and U.S. nationals) were similarly victims of
tyranny and should not be unfairly burdened by being taxed on
compensation if their actual properties cannot be restored.

Another argument is that it would be discriminatory to allow taxpayers
(who did not take a tax deduction) to receive restituted or substitute
properties tax-free, whereas those who receive monetary compensation
that exceeds the original basis of the property (which may happen in
most cases), will have the excess taxed as ordinary or capital gains.
This would be contrary to the doctrine of horizontal tax equity, under
which taxpayers in similar circumstances should be taxed in similar
ways. This doctrine has a constitutional foundation; under the equal
protection clause, tax legislation enjoys the greatest degree of freedom
to classify.

When the normalization of U.S.-Cuba relations commences, the IRS will be
confronted with unprecedented tax issues. In addition to Fortune 1000
companies, as many as one million Cuban-American taxpayers may have
property claims against assets valued in tens of billions of dollars.
Because of the unique circumstances involving politics, history and
geography, the U.S. government will need to address these special tax
circumstances in ways that redress past injustices and encourage
positive economic, political, and social changes in Cuba.

Notes

(1) Statement of Senator Richard Stone (D-FL), Outstanding Claims
Against Cuba, Hearings Before Subcommittees on International Economic
Policy & Trade, and on Inter-American Affairs, Committee on Foreign
Affairs, House of Representatives, 96th Cong., Sept. 25, 1979, at 6 (1980).

(2) For example, North American Sugar Industries owned a tract of land
approximately 42 miles by 30 miles (3,300 square kilometers) and three
sugar mills, including two of Cuba’s largest.

(3) Joint Corporate Committee on Cuban Claims 2005.

(4) IRC § 1.1033(a)(2)(c).

(5) Ted Bardacke, Mexican firm breaks new ground in Cuban telecom field,
DEVELOPMENT BUSINESS, July 31, 1994.

(6) FCSC: 2001 Annual Report, FOREIGN CLAIMS SETTLEMENT COMMISSION OF
THE UNITED STATES, U.S. Dept. of Justice (2001).

(7) Like Havana, the demand for housing in Berlin far exceeds the
supply. Prices for residential properties in the most desirable parts of
the city reach 6-7,000 EUR per sq, meter ($2,575-$3,000 per sq. ft.),
and the average in the city is 2,300 EUR per sq. meter ($986 per sq. ft).

*Sr. Research Associate, Institute for Cuban and Cuban-American Studies,
University of Miami and Consultant, Duane Morris, LLP.

**Consultant, Mastrapa Consultants.

***This Focus is based entirely on the previously published article
co-authored by Timothy Ashby and Tania Mastrapa, "Taxation of Cuban
Confiscated Assets After Property Claims Settlements: Issues for
Taxpayers and the US Government," International Law Quarterly 21, no. 1
(Summer 2005):5-11

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An Information Service of the
Cuba Transition Project
Institute for Cuban and Cuban-American Studies
University of Miami

Issue 71
October 2006

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