132 T.C. No. 4
UNITED STATES TAX COURT
HENRY AND SUSAN F. SAMUELI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
THOMAS G. AND PATRICIA W. RICKS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 13953-06, 14147-06. Filed March 16, 2009.
Ps-S purchased an approximate $1.64 billion of securities from F in October 2001 and simultaneously transferred the securities back to F pursuant to F’s promise to transfer identical securities to Ps-S on Jan. 15, 2003. The agreement between Ps-S and F allowed Ps-S to require an earlier transfer of the identical securities only by terminating the transaction on July 1 or Dec. 2, 2002. Ps-S did not require an earlier transfer and sold the securities to F on Jan. 15, 2003. Ps treated the transaction as a securities lending arrangement subject to sec. 1058, I.R.C., and Ps-S reported an approximate $50.6 million long-term capital gain on the sale. Ps also deducted millions of dollars of interest related to the transaction. R determined that the transaction was not a securities lending arrangement subject to sec. 1058, I.R.C. Instead, R determined that Ps-S purchased the - 2 -
securities from and immediately sold the securities to F in 2001 at no gain or loss and then repurchased from (pursuant to a forward contract) and immediately resold the securities to F in 2003 realizing an approximate $13.5 million short-term capital gain. R also disallowed all of Ps’ interest deductions because the corresponding debt that Ps claimed was related to the transaction did not exist. Held: The transaction is not a securities lending arrangement subject to sec. 1058, I.R.C., because the ability of Ps-S to cause F to transfer the identical securities to Ps-S on only three of the approximate 450 days during the transaction period reduced their “opportunity for gain * * * in the transferred securities” under sec. 1058(b)(3), I.R.C. The substance of the transaction was the purchases and sales that R determined. Held, further, Ps are not entitled to their claimed interest deductions because the debt Ps claimed was related to the transaction did not exist.
Nancy L. Iredale, Jeffrey G. Varga, and Stephen J.
Turanchik, for petitioners.
Miles B. Fuller and Louis B. Jack, for respondent.
OPINION
KROUPA, Judge: These consolidated cases are before the
Court on petitioners’ motion for summary judgment and
respondent’s cross-motion for partial summary judgment.
Respondent determined a $2,177,532 deficiency for 2001 and a
$171,026 deficiency for 2003 in the Federal income taxes of Henry
and Susan F. Samueli (collectively, Samuelis). Respondent
determined a $6,126 deficiency for 2001 in the Federal income tax - 3 -
of Thomas G. and Patricia W. Ricks (collectively, Rickses). Each
deficiency relates to petitioners’ participation in a leveraged
securities transaction (Transaction).1 Petitioners treated the
Transaction as a securities lending arrangement subject to
section 1058,2 the provisions of which we set forth in an
appendix.
These cases present an issue of first impression on the
interpretation of section 1058(b)(3). Specifically, we decide
whether the agreement (Agreement) underlying the Transaction did
“not reduce the * * * opportunity for gain of the transferor of
the securities in the securities transferred” within the meaning
of section 1058(b)(3). We agree with respondent’s primary
determination that the Agreement did reduce the Samuelis’
opportunity for gain in the securities (Securities) transferred
in the Transaction. Accordingly, we hold that the Transaction
did not qualify as a securities lending arrangement under section
1058. We also decide whether petitioners may deduct interest
claimed paid with respect to the Transaction. We hold they may
not because the debt that petitioners claimed was related to the
Transaction did not exist.
1 The Samuelis were the primary participants in the Transaction. The relevant participation of the Rickses involved their claim to an interest deduction related to the Transaction. 2 Section references are to the applicable versions of the Internal Revenue Code, and Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise stated. - 4 -
Background
I. Preliminaries
The parties filed an extensive stipulation of facts with
accompanying exhibits. We treat the facts set forth in this
background section as true solely for purposes of deciding the
parties’ motions, not as findings of fact for these cases. See
Fed. R. Civ. P. 52(a); P & X Mkts., Inc. v. Commissioner,
106 T.C. 441, 442 n.2 (1996), affd. without published opinion
139 F.3d 907 (9th Cir. 1998).
II. Individuals and Entities
A. Overview of Petitioners
Petitioners are two couples, each husband and wife, who
filed joint Federal individual income tax returns for the
relevant years. Each petitioner resided in California when his
or her petition was filed with the Court.
B. Mr. Samueli
Henry Samueli (Mr. Samueli) is a billionaire who co-founded
Broadcom Corporation, a publicly traded company listed on the
NASDAQ Exchange.
C. H&S Ventures
H&S Ventures, LLC (H&S Ventures), was a limited liability
company that was treated as a partnership for Federal tax
purposes. Mr. Samueli owned 10 percent of H&S Ventures, Susan
Samueli owned 10 percent of H&S Ventures, and the Samuelis’ - 5 -
grantor trust (Shiloh) owned the remaining 80 percent of H&S
Ventures.3 H&S Ventures was the primary entity through which the
Samuelis conducted their business affairs.
D. Mr. Ricks and Mr. Schulman
Thomas Ricks (Mr. Ricks) was the chief investment officer
for H&S Ventures and an investment adviser to the Samuelis.
Michael Schulman (Mr. Schulman) was the managing director of H&S
Ventures and the Samuelis’ personal attorney.
E. TFSC
Twenty-First Securities Corporation (TFSC) was a brokerage
and financial services firm specializing in structuring leveraged
securities transactions for wealthy clients. TFSC structured the
Transaction for the Samuelis. TFSC was unrelated to the
Samuelis.
III. Genesis of the Transaction
TFSC had forecast in 2001 that interest rates would decline.
Katherine Szem (Ms. Szem), then a tax partner with Arthur
Andersen LLP, discussed with Thomas Boczar (Mr. Boczar), Director
of Marketing for Financial Institutions at TFSC, the pricing and
mechanics of a leveraged securities transaction for the Samuelis.
Ms. Szem suggested to Mr. Schulman that the Samuelis consider
entering into a leveraged securities transaction.
3 The parties agree that Shiloh is disregarded for Federal tax purposes because it was a grantor trust subject to secs. 671 through 679. We refer to Shiloh as the Samuelis. - 6 -
Mr. Boczar forwarded to Mr. Ricks hypothetical leveraged
transactions using fixed-income securities including U.S.
Treasury STRIPS and agency STRIPS,4 such as those from the
Federal Home Loan Mortgage Corporation (Freddie Mac). The
profitability of these transactions hinged on a fluctuation of
market interest rates favorable to the investor; i.e., an
investor would borrow money at a variable interest rate to invest
in fixed-income securities and could realize a gain from the
investment if market interest rates then declined. Two days
later, Mr. Ricks recommended to Mr. Schulman that the Samuelis
invest in a proposed leveraged securities transaction. Shortly
after that, the Samuelis decided to make such an investment.
IV. The Transaction
A. Investors in the Transaction
The Samuelis, the Rickses, and Mr. Schulman invested in the
Transaction. The Samuelis held a 99.5-percent interest in the
Transaction. The Rickses and Mr. Schulman collectively held the
remaining one-half-percent interest. The Rickses’ interest was
.2 percent, and Mr. Schulman’s interest was .3 percent.
4 The word “STRIPS” is an acronym for the investment term “Separate Trading of Registered Interest and Principal of Securities.” See Acronyms, Initialisms & Abbreviations Dictionary 3455 (20th ed. 1996). - 7 -
B. Documents Underlying the Transaction
The Transaction was governed by five written documents
entered into by and between the Samuelis and their securities
broker, Refco Securities, LLC (Refco). These documents were
a(n): (1) Master Securities Loan Agreement (MSLA); (2) Amendment
to Master Securities Loan Agreement (Amendment); (3) Addendum to
the Master Securities Loan Agreement (Addendum); (4) Client’s
Agreement/Margin Agreement (Client Agreement); and (5) Refco
Statement of Interest Charges Pursuant to the “Truth-In-Lending”
Rule 10(b)-16. The MSLA, the Amendment, and the Client Agreement
were each entered into on or about October 11, 2001. The
Addendum was dated October 17, 2001.
C. Specifics of the Transaction
The Samuelis and Refco entered into the MSLA and the
Amendment approximately a week after the TFSC’s marketing
director contacted the Samuelis’ trusted adviser. Both the MSLA
and the Amendment were on standard forms used by the Bond Market
Association.5 The MSLA and the Amendment required the Samuelis
to acquire the Securities from Refco through the use of a margin
loan and then to “loan” the Securities to Refco. The MSLA and
the Amendment allowed the Samuelis to terminate the Transaction
5 The Bond Market Association (formerly known as the Public Securities Association) was the international trade association for the bond market industry. The Bond Market Association merged with the Securities Industry Association on Nov. 1, 2006, to form the Securities Industry & Financial Markets Association. - 8 -
(and thus cause Refco to transfer to the Samuelis securities
identical to the Securities) by giving notice to Refco before the
close of business on any “business day.”6 The Client Agreement
allowed Refco to hold the Securities as security for the margin
loan and to subject the Securities to a general lien and right of
setoff for all obligations of the Samuelis to Refco.
Refco and the Samuelis also entered into the Addendum.
Unlike the MSLA and the Amendment, the Addendum was customized
and provided that the Samuelis’ “loan” of the Securities to Refco
would terminate on January 15, 2003 (and thus require Refco on
that date to provide the Samuelis with the Securities). The
Addendum also allowed the Samuelis to terminate the Transaction
earlier on July 1 or December 2, 2002 (early termination dates).
Refco could purchase the Securities from the Samuelis at a price
established under a LIBOR-based formula set forth in the Addendum
if the Transaction was terminated on either early termination
date.7
6 The MSLA defined a “business day” as a day on which regular trading occurred in the principal market for the Securities. We include the identical securities in our term “Securities.” 7 “LIBOR” is an acronym for “London Interbank Offering Rate.” See generally Bank One Corp. v. Commissioner, 120 T.C. 174, 189 (2003), affd. in part and vacated in part sub nom. J.P. Morgan Chase & Co. v. Commissioner, 458 F.3d 564 (7th Cir. 2006). - 9 -
D. The Samuelis’ 2001 Purchase
The Samuelis purchased the Securities from Refco in October
2001.8 The Securities consisted of a $1.7 billion principal
STRIP of the $5.7 billion principal on an unsecured fixed-income
obligation issued by Freddie Mac. The maturity date of the
obligation was February 15, 2003, and the yield to maturity on
October 17, 2001, at which the Securities accrued interest, was
fixed at 2.581 percent.
The Samuelis purchased the Securities at a price of
$1,643,322,000 ($1.64 billion). The Samuelis paid the $1.64
billion by obtaining a margin loan of the same amount from Refco
pursuant to the Client Agreement. The Samuelis deposited $21.25
million with Refco to obtain the margin loan. Refco held the
Securities as security for the margin loan, and the Securities
were subject to Refco’s general lien and right of setoff for all
of the Samuelis’ obligations to Refco.
Mr. Ricks paid $42,500 to participate in the Transaction.
He paid this amount to purchase the Rickses’ .2-percent ownership
interest in the Securities owned by the Samuelis
($42,500/$21,250,000 = .2%).
8 The trade underlying this purchase was placed on Oct. 17, 2001, and the trade settled on Oct. 19, 2001. - 10 -
E. The Samuelis’ 2001 Transfer
The Samuelis transferred the Securities to Refco when their
trade for the purchase of the Securities settled. The MSLA
required Refco to transfer “cash collateral” to the Samuelis
equal to at least 100 percent of the market value of the
Securities before or concurrently with the Samuelis’ transfer.
Refco transferred $1.64 billion to the Samuelis as cash
collateral contemporaneously with the Samuelis’ transfer of the
Securities to Refco. The Samuelis used that $1.64 billion upon
receipt to repay the margin loan. The MSLA stated that the
Samuelis were entitled to receive all interest, dividends, and
other distributions attributable to the Securities.
F. Variable Rate Fee
The Samuelis were obligated to pay Refco a fee (variable
rate fee) for use of the $1.64 billion cash collateral. The
amount of the variable rate fee was calculated by applying a
market-based variable interest rate to the amount of the cash
collateral. That variable rate generally reset on the first
Monday of each month from November 5, 2001, to January 14, 2003,
to a rate equal to 1-month LIBOR plus 10 basis points. The
variable rate was 2.60125 percent from October 19 to November 4,
2001, and decreased steadily through January 15, 2003, to 1.48
percent. The Samuelis accrued interest on their $21.25 million
deposit at the same rate as the variable rate. - 11 -
V. The Samuelis’ December 2001 Payment
Petitioners calculated that $7,815,983 ($7.8 million) of
interest had accrued on the cash collateral as of December 28,
2001, and on that date the Samuelis (on behalf of themselves, the
Rickses, and Mr. Schulman) wired the $7.8 million to Refco as
payment of that interest. Mr. Boczar had informed Mr. Ricks
approximately two weeks before that the money could be returned
to the Samuelis two weeks after the transfer. Refco applied the
$7.8 million to reduce the variable rate fee calculated as owed
to it with respect to the cash collateral.
Refco transferred $7.8 million to the Samuelis approximately
two weeks after the Samuelis’ transfer, and Refco recorded its
transfer to the Samuelis as additional cash collateral. The MSLA
allowed the Samuelis to borrow an additional $7.8 million because
the Securities had increased in value.
VI. Termination of the Transaction
The Samuelis did not terminate the Transaction on either
early termination date, and the Transaction terminated on
January 15, 2003. Refco obligated itself on the termination day
to pay the Samuelis $1,697,795,219 ($1.69 billion) to purchase
the Securities in lieu of transferring the Securities to the
Samuelis. The $1.69 billion reflected the amount for which the
Securities were trading on January 15, 2003. Simultaneously with
Refco’s obligating itself to pay the $1.69 billion to the - 12 -
Samuelis, the Samuelis obligated themselves to pay $1,684,185,567
($1.68 billion) to Refco. The $1.68 billion reflected repayment
of the $1.64 billion cash collateral, plus unpaid variable rate
fees that had accrued during the term of the Transaction.
The Samuelis determined that they realized a $13,609,652
($13.6 million) economic gain on the Transaction. The $13.6
million economic gain resulted from the $1.69 billion that Refco
obligated itself to pay to the Samuelis less the $1.68 billion
that the Samuelis obligated themselves to pay to Refco. The
Samuelis received a $35,388,983 ($35.3 million) wire transfer
from Refco on January 16, 2003. The $35.3 million reflected the
$13.6 million determined economic gain, plus a return of the
$21.25 million the Samuelis deposited with Refco to obtain the
margin loan, plus accrued interest of $529,331.
VII. Petitioners’ Reporting Position
The Samuelis claimed an interest deduction on their return
for 2001 for their reported portion of the $7.8 million wired to
Refco as an accrued interest payment on December 28, 2001. Their
reported portion, $7,796,903, was an approximate 99.8 percent of
the total payment. The Rickses also claimed on their return for
2001 an interest deduction for their portion of the $7.8 million.
Their portion, $15,667, was .2 percent of the total payment. - 13 -
On their return for 2003, the Samuelis reported that they
realized a $50,661,926 long-term capital gain from the
Transaction. They calculated that gain as follows:
Proceeds of sale of securities from the Samuelis to Refco $1,697,795,219 Less: Purchase price of securities 1,643,322,000 Less: Transaction costs 3,556,710 Gain 50,916,509 The Samuelis’ 99.5-percent ownership interest .995 Capital gain to the Samuelis 50,661,926
The Samuelis reported the $50,661,926 gain as a long-term capital
gain because they held the Securities for over a year.
The Samuelis treated the $1.68 billion (the original cash
collateral plus the unpaid variable rate fees) as accrued cash
collateral fees and claimed they were entitled to deduct a
portion ($32,792,720) as interest for 2003. The Rickses did not
deduct any cash collateral fees for 2003.
VIII. Respondent’s Determination
Respondent determined that the Transaction did not qualify
as a securities lending arrangement under section 1058. Instead,
respondent determined that the Samuelis purchased the Securities
from and immediately sold the Securities to Refco in October 2001
and then repurchased from (pursuant to a forward contract) and
immediately resold the Securities to Refco in January 2003.9
Thus, respondent determined, the Samuelis realized no gain or
9 We use the term “forward contract” to refer to a contract to buy the Securities for a fixed price on a date certain. - 14 -
loss on the sale in 2001 and realized a short-term capital gain
of $13,541,604 on the sale in 2003. Further, respondent
determined, petitioners could not deduct the cash collateral fees
claimed paid as interest in connection with the reported
securities lending arrangement because no debt existed.
Discussion
I. Overview
Petitioners argue in moving for summary judgment that the
Agreement satisfied each requirement set forth in section
1058(b). Respondent counters that he is entitled to partial
summary judgment because the Agreement did not meet the specific
requirement in section 1058(b)(3). Respondent does not challenge
petitioners’ assertion that the Agreement satisfied each of the
other requirements set forth in section 1058(b). We therefore
shall decide whether full or partial summary judgment is
appropriate.
II. General Rules for Summary Judgment
Summary judgment is intended to expedite litigation and to
avoid unnecessary and expensive trials of phantom factual issues.
See Fla. Country Clubs, Inc. v. Commissioner, 122 T.C. 73, 75
(2004), affd. 404 F.3d 1291 (11th Cir. 2005). A decision on the
merits of a taxpayer’s claim can be made by way of summary
judgment “if the pleadings, answers to interrogatories,
depositions, admissions, and any other acceptable materials, - 15 -
together with the affidavits, if any, show there is no genuine
issue as to any material fact and that a decision may be rendered
as a matter of law.” Rule 121(b). The moving party bears the
burden of proving that there is no genuine issue of material
fact, and factual inferences are drawn in a manner most favorable
to the party opposing summary judgment. See Dahlstrom v.
Commissioner, 85 T.C. 812, 821 (1985); Jacklin v. Commissioner,
79 T.C. 340, 344 (1982). Because summary judgment decides
against a party before trial, we grant such a remedy cautiously
and sparingly, and only after carefully ascertaining that the
moving party has met all requirements for summary judgment. See
Associated Press v. United States, 326 U.S. 1, 6 (1945).
III. Primary Issue Under Section 1058(b)(3)
The primary issue under section 1058(b)(3) is ripe for
summary judgment. That issue turns on the interpretation of
section 1058(b)(3), and the parties agree on all material facts
relating to the issue. Thus, to decide the issue we need only
interpret the plain meaning of the text “not reduce the * * *
opportunity for gain of the transferor of the securities in the
securities transferred” and apply that interpretation to the
agreed-upon facts. See Glass v. Commissioner, 124 T.C. 258, 281
(2005), affd. 471 F.3d 698 (6th Cir. 2006). We interpret that
text as written in the setting of the statute as a whole. See
Fla. Country Clubs, Inc. v. Commissioner, supra at 75-76; see - 16 -
also Huffman v. Commissioner, 978 F.2d 1139, 1145 (9th Cir.
1992), affg. T.C. Memo. 1991-144.
We focus on the meaning of the phrase “not reduce the * * *
opportunity for gain of the transferor of the securities in the
securities transferred.” We understand the verb “reduce” to mean
“to diminish in size, amount, extent, or number.” Webster’s
Third New International Dictionary 1905 (2002). We understand
the noun “opportunity” to mean “a combination of circumstances,
time, and place suitable or favorable for a particular activity
or action” and to be synonymous with the word “chance.” Id. at
1583. We therefore read the relevant phrase in the context of
the statutory scheme to mean that the Agreement will not meet the
requirement set forth in section 1058(b)(3) if the Agreement
diminished the Samuelis’ chance to realize a gain that was
present in the Securities during the transaction period. Stated
differently, the Samuelis’ opportunity for gain as to the
Securities was reduced on account of the Agreement if during the
transaction period their ability to realize a gain in the
Securities was less with the Agreement than it would have been
without the Agreement.
We conclude that the Agreement reduced the Samuelis’
opportunity for gain in the Securities for purposes of section
1058(b)(3) because the Agreement prevented the Samuelis on all
but three days of the approximate 450-day transaction period from - 17 -
causing Refco to transfer the Securities to the Samuelis. Absent
the Agreement, the Samuelis could have sold the Securities and
realized any inherent gain whenever they wanted to simply by
instructing their broker to execute such a sale. With the
Agreement, however, the Samuelis’ ability to realize such an
inherent gain was severely reduced in that the Samuelis could
realize such a gain only if the gain continued to be present on
one or more of the three stated days. Stated differently, the
Samuelis’ opportunity for gain was reduced by the Agreement
because the Agreement limited their ability to sell the
Securities at any time that the possibility for a profitable sale
arose.10
In so concluding, we reject petitioners’ argument that they
always retained the opportunity for gain in the Securities by
continuing to own the Securities from the day they purchased them
until the day they sold them. A taxpayer’s opportunity for gain
under petitioners’ theory is not reduced for section 1058
purposes if the taxpayer retains the opportunity for gain as of
the end of a loan period. The statute does not speak to
retaining the opportunity for gain. It speaks to whether the
opportunity for gain was reduced.
10 Petitioners concede that the Agreement increased the Samuelis’ risk of loss because the Samuelis could not terminate the Transaction at any time. We infer from this concession that the Agreement also reduced the Samuelis’ opportunity for gain as to the Securities. - 18 -
In addition, we read the relevant requirement differently
from petitioners to measure a taxpayer’s opportunity for gain as
of each day during the loan period. A taxpayer has such an
opportunity for gain as to a security only if the taxpayer is
able to effect a sale of the security in the ordinary course of
the relevant market (e.g., by calling a broker to place a sale)
whenever the security is in-the-money. A significant impediment
to the taxpayer’s ability to effect such a sale, e.g., as
occurred here through the specific 3-day limit as to when the
Samuelis could demand that Refco transfer the Securities to them,
is a reduction in a taxpayer’s opportunity for gain.
Nor did the Samuelis’ opportunity for gain turn, as
petitioners would have it, on the consequences of the Samuelis’
variable rate financing arrangement. Petitioners assert that
their opportunity for gain as to the Securities depended entirely
on whether their fixed return on the Securities was greater than
their financing expense (i.e., the variable rate fee paid to
Refco) and conclude that the Agreement did not reduce this
opportunity because they continued to retain this opportunity
throughout the transaction period. Section 1058(b)(3) speaks
solely to the transferor’s “opportunity for gain * * * in the
securities transferred” and does not implicate the consideration
of any independent gain that the transferor may realize outside
of those securities (e.g., through a favorable financing - 19 -
arrangement). Thus, while the profitability of the Transaction
may have depended on the return that the Samuelis earned on the
Securities vis-a-vis the amount of the variable rate fee that
they paid to Refco, the Samuelis’ opportunity for gain in the
transferred securities rested on the fluctuation in the value of
the Securities.
We also reject petitioners’ assertion that the Samuelis
could have locked in their gain in the Securities on any day of
the transaction period simply by entering in the marketplace into
a financial transaction that allowed them to fix their gain,
e.g., by purchasing an option to sell the Securities at a fixed
price. This assertion has no direct bearing on our inquiry.
Section 1058 concerns itself only with the agreement connected
with the transfer of the securities. Whether the Samuelis could
have entered into another agreement to lock in their gain is of
no moment.11
We also reject petitioners’ argument that section 1058(b)(3)
cannot contain a requirement that loaned securities be returned
11 Petitioners also assert that the Transaction is a routine securities lending transaction in the marketplace. We disagree. A lender could terminate a security loan on any business day under the standard form used in the marketplace. The parties to the Transaction, however, modified the standard form to eliminate that standard provision and to prevent the Samuelis from demanding that the Securities be transferred to them during the transaction period, except on the three specific days. - 20 -
to the lender upon the lender’s demand at any time because
section 512(a)(5)(B) specifically contains such a requirement.
Section 512(a)(5)(A) generally defines the phrase “payments with
respect to securities loans” by reference to “a security * * *
transferred by the owner to another person in a transaction to
which section 1058 applies.” Section 512(a)(5)(B) adds that
section 512(a)(5)(A) shall apply only where the agreement
underlying the transaction “provides for * * * termination of the
loan by the transferor upon notice of not more than 5 business
days.” Petitioners argue that sections 512(a)(5)(B) and
1058(b)(3) were enacted in the same legislation and that Congress
is presumed not to have included unnecessary words in a statute.
See, e.g., Kawaauhau v. Geiger, 523 U.S. 57, 62 (1998); Johnson
v. Commissioner, 441 F.3d 845, 850 (9th Cir. 2006). Petitioners
conclude that part of section 512(a)(5)(B) would be surplusage
were a prompt return of a security already a requirement of
section 1058(b). Again, we disagree.
Our reading of section 1058(b)(3) to require that the lender
be able to demand a prompt return of the loaned securities does
not render any part of section 512(a)(5)(B) surplusage. Section
1058(b)(3) does not require explicitly that a securities loan be
terminable within a set period akin to the 5-day period of
section 512(a)(5)(B). It does not necessarily follow, however,
as petitioners ask us to conclude, that section 1058(b)(3) fails - 21 -
to require that the lender be able to demand a prompt return of
the loaned securities. The firmly established law at the time of
the enactment of those sections provided that a lender in a
securities loan arrangement be able to terminate the loan
agreement upon demand and require a prompt return of the
securities to the lender. We read nothing in the statute or in
its history that reveals that Congress intended to overrule that
firmly established law by enacting sections 512(a)(5)(B) and
1058(b)(3). We decline to read such an intent into the statute.
Such is especially so given the plain reading of the terms
“reduce” and “opportunity for gain” and our finding that the
Agreement reduced the Samuelis’ opportunity for gain by limiting
their ability to sell the Securities at any time that the
possibility for a profitable sale arose.
We recognize that unequivocal evidence of a clear
legislative intent may sometimes override a plain meaning
interpretation and lead to a different result. See Consumer
Prod. Safety Commn. v. GTE Sylvania, Inc., 447 U.S. 102, 108
(1980); see also Albertson’s, Inc. v. Commissioner, 42 F.3d 537,
545 (9th Cir. 1994), affg. 95 T.C. 415 (1990). The legislative
history of the applicable statute supports the plain meaning of
the relevant text and does not override it. Congress enacted
section 1058 mainly to clarify the then-existing law that applied
to the loan of securities by regulated investment companies and - 22 -
tax-exempt entities, on the one hand, and by general security
lenders, on the other hand. See S. Rept. 95-762, at 4 (1978).
The former group of lenders was concerned that payments made to
them by the borrowers of securities could be considered unrelated
business taxable income. See id. The latter group of lenders
was concerned that a securities loan could be considered a
taxable disposition. See id. at 5-6. Congress added section
1058 to the Code to address each of these concerns, explicitly
providing through the statute that payments from borrowers to
tax-exempt entities were considered investment income to the
tax-exempt entities and clarifying that the existing law that
applied to lenders of securities in general continued to apply.
See id. at 6-7.
The Senate Committee on Finance noted that owners of
securities were reluctant under existing law to enter into
securities lending transactions because the income tax treatment
of those transactions was uncertain. See id. at 4. The
committee also noted that the Commissioner apparently agreed that
a securities lending transaction was not a taxable disposition of
the loaned securities and that the transaction did not interrupt
the lender’s holding period, but that the Commissioner had
recently declined to issue rulings stating as much. See id. at
4. The committee believed a clarification of existing law was
required to encourage organizations and individuals with - 23 -
securities holdings to enter into securities lending transactions
so as to allow the lendee brokers to deliver the securities to a
purchaser of the securities within the time required by the
relevant market rules. See id. at 5. The committee explained
that section 1058 codified the existing law on securities lending
arrangements that required that a contractual obligation subject
to that law did not differ materially either in kind or in extent
from the securities exchanged. See id. at 7.
This legislative history is consistent with our analysis.
The legislative history explains that section 1058 codified the
firmly established law requiring that a securities loan agreement
keep the lender in the same economic position that the lender
would have been in had the lender not entered into the agreement.
For example, the lender must possess all of the benefits and
burdens of ownership of the transferred securities and be able to
terminate the loan agreement upon demand. The firmly established
law came from the United States Supreme Court in Provost v.
United States, 269 U.S. 443 (1926). There, the taxpayers sought
to recover the cost of internal revenue stamps affixed by them to
“tickets” that evidenced transactions where shares of stock were
“loaned” to brokers or returned by the borrower to the lender,
each in accordance with the rules and practice of the Stock
Exchange. See id. at 449. The Court held that those transfers
of stock were taxable transfers within the meaning of the - 24 -
applicable Revenue Acts because “both the loan of stock and the
return of the borrowed stock involve ‘transfers of legal title to
shares of stock’.” Id. at 456. The Court noted that a lender of
securities under a loan agreement retained all of the benefits
and burdens of the loaned stock throughout the loan period, as
though the lender had retained the stock, and that both parties
to the loan agreement could terminate the agreement on demand and
thus cause a return of the stock to the lender.12 See id. at
452-453.
12 The Commissioner later ruled similarly in Rev. Rul. 57-451, 1957-2 C.B. 295. That ruling, which is referenced in the legislative history to sec. 1058, see S. Rept. 95-762, at 4 (1978), states in relevant part:
The second situation described above, wherein the optionee authorizes the broker to “lend” his stock certificates to other customers in the ordinary course of business, presumably anticipates the “loan” of the stock to others for use in satisfying obligations incurred in short sale transactions. In such a case, all of the incidents of ownership in the stock and not mere legal title, pass to the “borrowing” customer from the “lending” broker. For such incidents of ownership, the “lending” broker has substituted the personal obligation, wholly contractual, of the “borrowing” customer to restore him, on demand, to the economic position in which he would have been as owner of the stock, had the “loan” transaction not been entered into. See Provost v. United States, 269, U.S. 443, T.D. 3811, C.B. V-1, 417 (1926). Since the “lending” broker is not acting as the agent of the optionee in such a transaction, he must have necessarily obtained from the optionee all of the incidents of ownership in the stock which he passes to his “borrowing” customer. [Rev. Rul. 57-451, 1957-2 C.B. at 297.] - 25 -
We conclude that the Transaction was not a securities
lending arrangement subject to section 1058 and that the
underlying transfers of the Securities in 2001 and 2003 were
therefore taxable events. Respondent determined and argues that
the Samuelis’ transfer of the Securities to Refco in 2001 was in
substance a sale of the Securities by the Samuelis in exchange
for the $1.64 billion they received as cash collateral and that
Refco’s purchase of the Securities in 2003 was a second sale of
the Securities by the Samuelis in exchange for the money wired to
them on January 16, 2003. For Federal tax purposes, the
characterization of a transaction depends on economic reality and
not just on the form employed by the parties to the transaction.
See Frank Lyon Co. v. United States, 435 U.S. 561, 572-573
(1978).
We agree with respondent that the economic reality of the
Transaction establishes that the Transaction was not a securities
lending arrangement as structured but was in substance two
separate sales of the Securities without any resulting debt
obligation running between petitioners and Refco from October
2001 through January 15, 2003.13 The transfers in 2001 were in
13 The Transaction is similar to the transactions involved in a long line of cases involving M. Eli Livingstone, a broker and securities dealer who aspired to create debt through initial steps that completely offset each other. Courts consistently disregarded those offsetting steps because they left the parties to the transactions in the same position they were in before the (continued...) - 26 -
substance the Samuelis’ purchase and sale of the Securities at
the same price of $1.64 billion. The Samuelis therefore did not
realize any gain in 2001 as to the Securities. The transfers in
2003 were in substance the Samuelis’ purchase of the Securities
from Refco at $1.68 billion (the purchase price determined in
accordance with the terms of the Addendum, which operated as a
forward contract), followed immediately by the $1.69 billion
market-price sale of the Securities by the Samuelis back to
Refco. The Samuelis therefore realized a capital gain on the
sale in 2003 equal to the difference between the purchase and
sale prices. See sec. 1001. That capital gain is taxed as a
short-term capital gain because the Samuelis held the Securities
for less than a year.14 See sec. 1222.
13 (...continued) steps were taken. See, e.g., Cahn v. Commissioner, 358 F.2d 492 (9th Cir. 1966), affg. 41 T.C. 858 (1964); Jockmus v. United States, 335 F.2d 23, 29 (2d Cir. 1964); Rubin v. United States, 304 F.2d 766 (7th Cir. 1962); Lynch v. Commissioner, 273 F.2d 867, 872 (1st Cir. 1959), affg. 31 T.C. 990 (1959) and Julian v. Commissioner, 31 T.C. 998 (1959); Goodstein v. Commissioner, 267 F.2d 127, 131 (2d Cir. 1959), affg. 30 T.C. 1178 (1958); MacRae v. Commissioner, 34 T.C. 20, 26 (1960), affd. on this issue 294 F.2d 56 (9th Cir. 1961). The courts did not disregard the transactions entirely as shams or as lacking economic substance. The courts disregarded the initial steps and recast the transactions as exchanges of promises for future performance. The transaction in one case was even recast where the taxpayer made an economic profit. See Rubin v. United States, supra. 14 Petitioners argue they still prevail even if we accept, as we do, respondent’s characterization of the Transaction. Petitioners assert that their sale of the Securities in 2003 was in consideration for their surrender of their contractual right (continued...) - 27 -
IV. Secondary Issue Concerning Interest Deductions
The secondary issue for decision involves petitioners’ claim
to interest deductions. Our decision as to this issue also does
not turn on any disputed fact. Thus, this issue is also ripe for
summary judgment.
Respondent disallowed petitioners’ deductions for interest
paid to Refco in 2001 and in 2003 because “there was no
collateral outstanding and the payment did not represent a
payment of interest ‘on indebtedness’.” Petitioners argue that
their payment in 2001 was made with respect to debt in the form
of the cash collateral. Again, we disagree. We conclude on the
basis of the recharacterized transaction that petitioners may not
deduct their claimed interest payments for 2001 and 2003 because
those payments were unrelated to debt. The cash transferred in
2001 represented the proceeds of the first sale and not
collateral for a securities loan. Thus, no “cash collateral” was
outstanding during the relevant years on which the claimed
collateral fees could accrue. Nor did the Samuelis transfer any
cash in 2003 with respect to debt. Their transfer of cash in
14 (...continued) to receive the Securities. Petitioners assert that this contractual right was a long-term asset acquired in October 2001 and that they may offset the $1.69 billion sale proceeds by their $1.64 billion basis in that long-term asset. We disagree with this argument. The Securities were the subject of the sale in 2003, not the surrender of a contractual right as petitioners assert. In addition, the Samuelis transferred the $1.64 billion to Refco in 2001 to purchase the Securities. - 28 -
2003 was to purchase the Securities pursuant to the forward
contract. Accordingly, we hold that petitioners are not entitled
to their claimed interest deductions.
V. Epilogue
We have considered all arguments petitioners have made and,
to the extent not discussed, we have rejected those arguments as
without merit. To reflect the foregoing,
An appropriate order
will be issued. - 29 -
APPENDIX
SEC. 1058. TRANSFERS OF SECURITIES UNDER CERTAIN AGREEMENTS.
(a) General Rule.--In the case of a taxpayer who transfers securities (as defined in section 1236(c)) pursuant to an agreement which meets the requirements of subsection (b), no gain or loss shall be recognized on the exchange of such securities by the taxpayer for an obligation under such agreement, or on the exchange of rights under such agreement by that taxpayer for securities identical to the securities transferred by that taxpayer.
(b) Agreement Requirements.--In order to meet the requirements of this subsection, an agreement shall--
(1) provide for the return to the transferor of securities identical to the securities transferred;
(2) require that payments shall be made to the transferor of amounts equivalent to all interest, dividends, and other distributions which the owner of the securities is entitled to receive during the period beginning with the transfer of the securities by the transferor and ending with the transfer of identical securities back to the transferor;
(3) not reduce the risk of loss or opportunity for gain of the transferor of the securities in the securities transferred; and
(4) meet such other requirements as the Secretary may by regulation prescribe.
(c) Basis.--Property acquired by a taxpayer described in subsection (a), in a transaction described in that subsection, shall have the same basis as the property transferred by that taxpayer.