TAX COURT OPINION

Case: Lizzie W. & Albert L. Calloway
Docket Number: 8438-07
Judge: Ruwe
Opinion Type: reported
Filed: 07/08/2010
Pages: 75

LIZZIE W . AND ALBERT'L .-CALLOWAY, Petitioners v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No .. 8438-07 . Filed July 8, 2010 . In August .2001 P entered into an agreement with Derivium whereby P-transferred 990 shares'-of IBM common stock to Derivium in exchange for $93,586 .23 . The terms of the agreement ;characterized the transaction a s a .loanof 90 percent of the . value of the IBM stoc k pledged as collat'eral. . The purported loan was nonrecourse and prohibited P from making any interest or-principal payments-during the .3-year term "of th e purported loan . The terms of the agreement allowe d .which it did immediatel y Derivium 'to .%sell the .stock ; upon receipt . At maturity P had the option of either paying the balance due, and having- anu equivalent' amoun t of IBM stock returned to him, renewing the purported loan for an'additional ;term, or satisfying the "loan" by surrendering-any right to receive IBM-stock . At maturity in August 2004 the balance due was°$4'0, 924 .57 more than the then value of the IBM stock . P ..elected . to satisfy his purported ba r to receive IBM stock . P was not required to and,di d SERVED JUL - 8 2010 .not-make any payments toward either principal o r interest on the purported loan . 1 . Held : The transaction between P and Deriviu m in August 2,001 was a sale . P transferred all th e benefits and burdens of . ownership of the stock t o Derivium for $93,586 .23 with no obligation to repa y that'amount 2 . Held , further , the transaction was no t analogous to the securities lending arrangement in Rev . Rut . 57-451, 1957-2 C .B . 295, nor-was it equivalent t o a securities lending arrangement under sec . 1058, , I .R .C . 3 . Held , further , Ps are liable for an additio n to tax under sec . 6651(a)(1), I .R .C ., for the late filing of their 2001 Federal income tax return . 4 . Held , further , Ps are liable for the accuracy- related penalty pursuant to sec .' 6662, I .R .C . Brian G . Isaacson , . for petitioners .. Daniel J . Parent , for respondent . RUWE, Jude : Respondent determined a $30,911 deficiency , $6,583 addition t o tax under section 6651 .(a)(1)' for failure t o timely file, .and a $6,182 .20-,accuracy-related penalty unde r section 66621 .(a)-,i n tax . The issue s we must :. decide are : . (1)b Whether 'a transaction in which Albert Calloway (petitioner.) .t'ransferred 990 share s of International Business Machines Corp°. .( .IBM) common stock t o Der..ivium Capital, L .L .C .' .(Derivium), in-exchange for $93, 586 .2 3 was a sale or'a loan ; . (2) whether the transaction qualifies as a 'All'section references are to the Internal Revenue Code as amended,"and Rule references are to the Tax Court Rules of Practice and Procedure . secur.ities .l.endi-ng .arrangement ;'(3) whether-petitioners ..are. . liable for an addition to tax°under .section 6651(a)'(l). .fo r failure to timely . firle ; and '(4) .whether' .petitioners are liabl e for an :accuracy-related penalty pursuant to-,,section 6662(a ) FINDINGS OF FAC T Some of'-the -facts- .have been 'stipulated and are so found . The stipulated facts ;and-.the-attached exhibits are-incorporate d herein by .this reference . .At the the petition was" .filed , petitioners-'resided in Georgia . After petitioner graduated from college in 1964, he began a successful career with IBM . While employed at IBM petitione r purchased shares of IBM stock . During 2001 petitioner's financial adviser , introduced him to Derivium and its 90-percent-stock-loa n program .2 Under that pro gramDerivium would .purport to lend 9 0 percent of-the^-value of securities pledged to Derivium" a New York Stoc k Exchange or":the'eNational Association of,,Securitie s Dealers/Financial Industry' .Regulatory Authority' . Charle s 2 The use of the terms " l o. an" " collateral "" , . "borrow " , . .. "hedge", andy "maturity" with all . -related terms ,throughout this Opinion is merely for convenience in describing what petitioners -contend the, transaction represents . . On or about August 6, 200.1,. Deriviumu sent . to, petitioner . a document entitled "Master Agreement to Provide-Fi-nancing'and . Custodial Services ."-(master agreement)with attached "Schedul e D, Disclosure Acknowledgement and .Broker/Bank Indemnification " (schedule D) . The master agreement provides, in .pertinent part : This Agreement ;is made for the,purposeof_'engaging * * * [Derivium] to provide ,or arrange financing(s) an d to. provide. custodial .- servicesto * * * [petitioner] with respect to certain properties and assets ("Properties") :to be pledged . as secu rity, the detail s of which financing and-Properties are to be set out in loan term, sheets . and attached hereto as .Schedule(s) .- A ("Schedule(s) A " ) The . schedule D to be executed in connection with .the maste r agreement states that the transaction was to "Provide Financin g and-Custodial Services entered into between Deriviu m * * * [ etitioner] " P h '(cid:127) f ,h p aragrap o sc edu e D, relating to th e l pledge of securities, provides, in pertinent part : [Petitioner] understands that by transferrin g securities as,,collateral.to-* *m* .[Der.ivium] and unde r the terms of the * * * [master agreement], * *" * [petitioner]-,gives .* * * [Derivium] the right, withou t notice to * * *.,,[petitioner], to transfer, pledge , repledge, hypothecate, rehypothecate,_ lend','° shortsell , and/or sell outright some or all of the securities during the period covered by the -.loan . [Petitioner] understands that * * [Derivium]has th e right to receive and retain the 'benefit's from any -suc h transactions and that * * * [petitioner] is not * 'entitled to these benefits during the term of a loan . * * * [Emphasis added . ] Derivium also sent to petitioner a=(cid:127)document entitled "Schedule A-1, Property Description and , Loan Terms" (schedule,A- 1), which sets forth the essential terms°of(cid:127)the transaction . Schedule A-l provides : This Schedule A* * * executed in connection with the Master Agreement to Provide Financing and Custodial Services entered into between Derivium * * * and [petitioner] '* * * o n 8/6/01 . ust 6th, 2001, is , dated Au g 1 .- ::Property. Description : " (cid:127)990 shares of International Business Machines Corporation . (IBM) . .$105,444 .90 ( as of: 8/6/01, at $106 .51 . per share) . -3 . Anticipated : Loan Amount : 10 .500, compounded annually, accruing until and due at maturity . All Dividends will be received as :cash payments against interest due . , with the balance of interest owed to accrue until maturity date . 3 years,' starting from the .date on which final loan proceeds are delivered on th e loan transaction . Margin a. Requirements : None.,-beyond initial collateral . 10 c, Non-Callable : 11 .. ..Non_Recourse : Non-recourse to borrower , recourse against the collateral only . The loan°may,bem .r.enewed .or refinanced at .borrower's request for an additional term, on the maturity date, within :*-* * [Derivium's] ,prevailing conditions and terms for loans at the time o f renewal or refinancing . On the renewal .or~refinancingo f any loan for which-90o of the .collateral value at maturity does not,equal°or exceed th e payoff amount, there will be a .renewal fee, which will be calculated as a percentage o f the balance due at maturity o f this loan . The''percentag e will vary according to'the market capitalization of the securities at the time of the renewal or refinancing, a s follows : Large,Caps~;at 4 .5%, .Mid Caps at .5 .50, Small Caps at 6 .5% . Upon receipt of securities an d .establishment-of * °* *' [ Derivium' s ] hedging transactions . Before entering into the agreement with Derivium, petitione r reviewed a memorandum dated December 12, 1998', from Robert J . Nagy , . who claimed to be a certified public accountant, to Mr . Cathcart regarding the ;~"Tax Aspects of'First Security Capital' s 90%-Stock Loan" that was requested by Mr . Cathcart . In-th e .memorandum Mr . Nagy describes a potential client as,one who owns publicly traded stock with a low basis,. which if sold would result in significant gain to the .client . Mr . Nagy describes, th e primary issue as,whether the 90-percent-stock-loan transaction i s -a sale or a loan and opines that, although there is no "absolut e assurances that-the desired tax treatment will be achieved" , there is a "solid basis for the .position that these transaction s are, in-fact, loans ." -Petitioner relied on .Mr . .Nagy's memorandum . to Mr Cathcart-in deciding whether, to enter into the, agreement Petitioner-testified that a loan versus a sale transaction made economic sense to him because the loan proceeds given to him were 90 percent of the value of the IBM stock .whereas if he had,sold the stock he would have had to pay 20 percent for taxes . Petitioner decided to'enter into the-90=percent-stock-loan program (transaction) withDerivium . Petitioner signed the master agreement, the schedule' D, and the schedule °A-1 on Augus t 8, 2001 . Charles D ._Cathcart, as president of-Derivium, signe d the master . agreement and the schedule A-1 .-on-August 10, 2001 . On or about August 9, .2001, petitioner instructed-Brian-J . Washington of First Union Securities, Inc ., .to transfer 990 shares of IBM common stock (IBM stock or collateral)-to Morgan Keegan &Co .- (Morgan Keegan) and to credit .Derivium's account . On August 16, 2001, Morgan Keegan credited Derivium's account , with the IBM stock transferred from petitioner' : The followin g day August 17', 2001, De'rivium sold ,the 990 sharers of IBM stock held in its Morgan Keegan account for $1 0 3,984 .65 (i .e . $105 .035 per share of IBM . common stock) The . netproceeds from Derivium's sale-of the IBM -stock were '°$1 .03, .918 .18 ('i . e .(cid:127), $103' 984 . 65 minus a $3 .47 . "S .E .C . Fee" and a $63 ''Comm'ission") . On August 22,: 2001 , .the net :proceeds from the sale of the'IBM stock :settled into Derivium's,Morgan Keegan account . On or about August 17, 2001,' Derivium'-s'operations offic e sent'to ;petit'i .oner two, documents . .. The .,first document, entitled Valuation,Confirmation",''indicates that Derivium-,.had receive d the IBM stock into its . Morgan Keegan account valued a t $104, 692 .50 (at a "Price per, .,."Share for Valuation' : of $105 .75) . Thus, Derivium .projected .the amount . it-would lend to petitioner as $94,223 .25 . The second document,' "Activity Confirmation", however, indicates that"as . of August 17,' 2 .001 , Derivium had "hedged" .the,=IBM stock fora "hedged value " $103,984 .70 .3 On the basis-of-the "hedged :' value Derivium determined petitioner's actual "loan" amount as'$93,586 .23'(i .e ., 90-percent of $103,'9.84 .70) Thus, the "l'oan'' amount was no t determined : until after .Derivium sold the IBM stock- . 'Derivium's Morgan Keegan account statement reflects a sale price . of $103, 984'' .'65 , for the 990 . shares of IBM common stock . The difference , between Derivium's,"hedged . value" of $103,984 .70 and the',$103,984 65 reported oh-Derivium's Morgan Keegan account statement . appears to be due to rounding . The Morgan .Keegan statement reports the share price at the time of sale-at $105 .035,, whereas Derivium's"Ac .tivity ..,,Confirmation" report indicates the share price at the'time the' shares were "hedged" at $105 .03505 . On August . 21, ..200.1, Deriv.ium sent . to petitioner.: alette r informing him that . the .,proceeds' .of the loan were -sent :to hi m according to :the' ..wire,,transfer instructionshe had provided a fe w days earlier .-'On thatsame date, a .$93,586 .23 wire transfer wa s received and, .credited to petitioner's 'account at IBM 'Southeas t Employees . Federal Credit Union . During the term of .--the"loan" Derivium'provided petitioner with quarterly and .yearend account statements . 'The quarterly acco.unt .statements reported "end-of-quarter. collateral value"'. and dividends ,,such that it appeared that .Derivium stil-1 held the IBM stock (i . e .-, Derivium . appears to have , reported the value of the .collateral .on the .basis of the'fai .r.market value of the IBM stock .at, the end of each calendar quarter . rather than . the $103,984 :65 of sale proceeds, and further . reported dividends on the IBM stock, which it credited against'-the interest accrued'during .the quarter,! as, if it continued, to hold all .990 shares of IBM 'stock) Petitioner neither . received a- Form 1099-DIV, . Dividends and= Distributions, .nor included any,IBM dividend income"-from th e .alleged dividends ;paid on- ;,the IBM 'stock on petitioners" 2001 , 2002, 2003, or 2004 Federal income tax return, . . .In a,letter dated . July 8, 2004, Derivium informed petitione r that . the loan "will mature on August 21, 2004" and thatth e "total . principal and interest that will be .due , and payable o n $124,429 .09" informed, petitioner that, as. -of July 8 ;'_2004 .,' the .value of °'990 shares o f IBM stock . was .,$83, 318 .40 . . .Derivium also 'reiterated td-petitione r that, .: pursuant to, the :terms and-conditions of the maste r agreement,'he was entitledgto'elect,one of the,, . foll o_wing thre e options ~-at -maturity : (1) "Pay the Matur' ity Amount and Recove r Your Collateral" ; ( 2) "Renew or Refinance 'thee, Transaction for"a n ;Additional Term" ; or -(3)w"Surrender .. Your' Collateral"' . On July' '27, 2004, petitioner responded to, Derivium' . s July 8 , 2004, letter,' stating°tha.t my/our,collateral-uin satisfaction . ; of ;my/..our entire 'deb t obligation" ; i e .-, petitioner relinquished the right ..to acquir e the .IBM stock valued ' at $ 83, 326 . 324 and' never' made any payment s of principalor interest on the $124,250 .'89(cid:127)balance due on th e "loan" .. On:: September, , notifying 'him that the loan matured on :Augusts -21, . 2004 ;°" and ,tha t the .balance' due was '$40,''924 :-.57 more . than the value-of the= IB M stock eon_ the .maturity , date . _ The partie's stipulate that the pric e per share of, IBM stock .was $105'..03 on =August '17'1,' 2001, an d approximately $84 .16. on July 8, :2004 . . 4The Sept. . . 8 ;''2004, letter indicates that >the 'dollateral , the IBM stock, was valued at $83,'326 .32, "using the average of the , closing' prices, as reported by'the Wall Street Journal ,' .for th e ten trading days-prior-to the maturity date ." On :Febru.ary 11, 2004 , petitioners filed their 2001==join t Federal income tax return .. Petitioners £did .:not'report the ' $93,586 :.23-received from Derivium,in exchangeefor'the .IBM'stoc k on their 2001Federal income taxreturn, .nor di d .termination of the transaction with Derivium'on,their' '200 4 :Federal-- income tax return . Petitioner'_s 'cost basis in' 'the 990 shares of -IBM stock wa s $21,171 . The .primary issue is whether the transaction, iri whic h petitioner transferred his .; IBM -stock -to Derivium" and " received $93, 586 . .23., was a "sale 'or 'a 'loan . Surprisingly, this case presents an 'issue -, of . first impres'sion in this 'Court=. 6 ' Nevertheless, there. .are many cases that provide-us with guiding : to . the' .transaction 'as 'a loan ; however, "Federa l .SLn .the notice of deficiency -respondent ' s .determination .was made using . a cost basis of $10, 399' for petitioner' s 990 shares o f IBM stock . 6There,are now other cases pending . in :the Tax Court- , involving Derivium-transact :.ions . We understand . that-from 1998 . to : similar transaction s (cid:127)2002 Derivium engaged in approximately 1,700 involving approximately $1 billion . United States Trustee, . 97 .AFTR 2d 2006-258.2, .at 2006-2583 . to 2 .006-2584 .(S .D .N .Y . 2006) . . The Government estimated the tota l tax loss associated,with Deriviums scheme to,be .;approximately $235 million . Complaint, U nited States v . Cathcart , No . 07-476 2 (N .D . Cal . filed Sept . 17, 2007) . Derivium Capital L .L .C . v . - 12 , concerned,with the . economic substance, of the transaction under scrutiny and .not,the ,form by which it is^masked . United States v . .Heller , 866 F .2d 1336 ; 1341 . (11th Cir . 1989,) ; ; see also Commissioner y .Court Holding Co ., 24 '- U .S . 331,'334 (1-945) ("Th e incidence of taxation depends .-upon the substance of ., transaction . To permit the true nature of .-,a . transactio n to be disguised-by mere formalisms,, which exist solely to,alter tax liabilities, would . seriously impair the effectiv e administration of the tax policies of-,Congress .") ; Gregory v . Helverina , 293 U . S . 465., w470 (1935) (finding the economic substance of a transaction to rbe . ,controll,ing- and stating :, "To hold, otherwise would be to exalt- .artifice above reality and to deprive the . :statutory provision}.in question of . all serious purpose " ) Whether the Transaction Was a Sale of IBM Stock . "The term 'sale' 'is .,given .i,ts ordinary meaning for Federal income tax purposes and is :=generally defined as .a transfer of property- for money or a promise to pay money .," . , Grodt & McKay Realty ; Inc . V . Commissioner, 77 T. . C .. 1221," 1237 (1981) (citin g Commissioner v . Brown , 380 U . S . 563 , 570-571-( 1965 )) . Since th e economic substanceof a transaction, rather' than its form , controls for tax purposes, the key to Jdeciding whether th e transaction was a sale or other disposition i s whether the benefits and'burdens of ownership °of .the IBM stock passed from petitioner to Derivium . Whether' .thebenefits an d -burdens .of ownership have .passed fron one taxpayer,Fto anothe r question -,of fact that is .'determined -from the -intention of th e parties as established by. .the' written' . agreements read in-th e light of the attendingfact .s,and ;circumstances See, Arevalo v . Commissioner , . .124 T'-C : 2,44,, .251-252 (2005)', affd I" 469 F .'3d 43 6 .(5th Cir . 2006 ) . Factors the,cour,ts"have'cons'idered in makin g this determination,include : Whether legal title passes ; (2 ) how the parties treat the : transaction'; .( 3) whether' an equity' ' interest- .in the . property acquired ;' (4'.), whether the contrac t create sta present obligation-on the' sellerato',' .ex'ecute and :delive r deed and--a present obligation' on' ,the purchaser to 'mak e payments ; (5) whether .(cid:127)the' right of possession .is. vested in the purchaser ; ('6 ) which -.part pays the .property taxes ; . °(7) which .party bears the' ri°s k of :-loss or damage -to" the property ; '° and - (8 ) which party' receives the profits from=,the" operation =and 'sale 'o f .the property . See id . at 252 ; see also Grodt-&-McKay-Realty , Applying the above factors leads us to the conclusion tha t On August 1 .6, 2001, petitioner transferred the . .IBM stock t o Derivium's Morgan .Keegan account .. The master .. agreement provides 14 - authorized-to sell .it without notice topetitioner_ . ..Deriviumn immediately, sold .: the stock . Thus, legal' title to-the stock ; passed to . Derivium in 200 1.when' petitioner transferred the IBM stock .pursuantto ..the terms of the master agreement . ' (2) . The, Parties' Treatment of the Transaction . In the master agreement the parties" characterize th e transaction as . a .loan- and characterize :the IBM -shares .as . collateral ., However, on-,-August . 4-17,2001,, the 'day after . "it received the IBM stock, Derivium sold'it . Derivium did not determine,the_value of the .so-called loan, to petitioner until after it had determined the proceeds it would receive-from-th . ,Although , petitioner, testified' that ;he di d e sale of the, IBM stock ,not know :Derivium had sold-the IBM stock and :that he believed -Derivium was only =acting as a custodian . of . the' stock, petitioner admitted'that-when. he signed the , agreement : he,knew,that he had authorized Derivium to,sell_the stock .8 Petitioners,, did no t 7Legal title is one, . of several factors in our test . and . may not be determinative in'every sintuation ; e .g ., :brokers holding stock for the accounts of,cus,tomers or as security for .advances' under highly regulated condition s . See Provost V .# United States , 269 U .S . 443 (1926) . Indeed, Congress .has provided that certain types of security' lending arrangements do not'have to be recognized as taxable transactions if they meet .*,the- .strict requirements of sec . 1058 .' See infra pp .'27-32 : ' BAt ;trial petitioner testified : Q What responsibilities do you believ e Derivium, let's call it DC, Derivium Capital, your report dividends paid : on - the, IBM -,stock yon wtheir }2001, 2002, 2003 , , .or.2004 Federal income tax return, and petitioner .. was .neve r required to repay any of~_the,principal or interest on'-the "loan" . Indeed, .even :though petitioners argue . that the ,':sale of thei-r . IBM stock- occurred . in 2004 , they failed to .report the "sale " .their IBM shares on :their 20 .04 Federal,income tax-return ., They also failed-to .alternatively report any relief of indebtednes s ,income from the transaction on,their,-200 4 petitioners did not treat this transactionin :'a manner with their own characterization of-the transaction . { .continue d A u"They had a' responsibility of'-*prbtecting m e throughout that three- .year. period to ensure that the stock -was there' at the" completion of the-transaction . f your IBM'rv . A I would' not have received anything-,,because, they had the right,, that-was something that I agreed to', bu t they also had the responsibility as- a .custod .an, :to return to' me the total' number' Hof 990 shares at' th e completion of the .tran .saction . - 1 6 (3)_ Equity Inherent ° in }the Stoc k Derivium acquired all property interest s ,and the' next .dayiall of Derivium's interest inthe stock wa s sold : ' .etitlo n er ;~retained no property - 'interest in the stock . ., A t best : he had an option to 'purchase an equivalent number . ' of 'IB M shares after 3 1years at Pa price equival ent 'to $ 93, 586' . 23 plu s ."interest'' . : The effectiveness : .of the option depended o n Derivium's abilityto acquire and deliver the,requir-ed number o f . .IBM 'shares in 2004 . (4) Obligation To Deliver and-Pa y The master agreement obligates petitioner to transfer th e r IBM stock to Derivium and .Derivium to pay .90'percent of the fai r market value of , the, stock . The amount,.Derivium had to pay wa s determined-after Derivium sold the IBM stock . (5) Whether the Right of Possession Passed Derivium obtained title to,'possession of,' and complete . control of _the IBM stock from petitioner . Derivium immediately , exercised those rights and sold the stock . (6) Payment of Property Taxe s This factor is inapplicable under the facts of this„cas e (7) The Risk of, Loss or Damag e Upon receipt of the $93,586 .23 from Derivium in 2001 , petitioner bore- . no risk 'of loss in the event' that,the .value o f the IBM-stock decreased . Petitioner'was entitled'to .retain all the . funds' transferred- .to him regardless of the 'performance of, th e IBM stock=in the financial marketplace . (8) ; Profits From; the P ropert y The ,master -agreement :provides . :_ [Petitioner] gives,-* * . *, [Derivi .um] the right, withou t notice to * * * [petitioner], to transfer, pledge , ,repledge, hypothecate, rehypothecate,x<lend, short sell , and/or sell outright some or all of the securitie s during the period covered by, the . loan .-*,*, [Petitioner] understands that ,*' * * [Derivium] has the right to receive and retain the benefits from any such transactions and . that *'_* * [petitioner] is no t entitled to, these benefits during .,the term 'of a -loan . , . At best the master agreement gave petitioner an option . to .repurchase IBM stock from .Derivium at the . end ; of the 3 however , this option' depended on Derivium 's ability to acquir e 9Petitoner testified that he had an option to reacquire 990 shares of-IBM stock by paying the balance due in 2004, but'he di d not exercise that : option, : A I had three orations as indicated in the , documentation ._ The option I chose was to relinquis h the shares in 2004 . Q> . So there . was n.o . requirement, that you had to . repay ;theloan ? A There was 'a choice . - ' I could' haven extended the loan, I could have . relinquished the loan, .,but the loan- , was, upside down . There- was a debt of $40,00'0 . I chose to . relinquish' the shares . That was in payment for the loan becoming .a taxable event in 2004 . As previously mentioned, petitioners failed to report a sale of the IBM stock on their 2004 Federal income tax return . - -18 - IBM stock in 2004 . . .The foregoing,factorsindicate that th e transaction was a sale of IBM .stock in=:2001 . . In the context of taxation,, .c'ourts have defined a loan a s n agreement, either express or implied, 'whereby one perso n advances money 'to :the other and the other, agrees " to'repay it upo n ..such terms as to'time and, rate of interest, .or withou't .interest , .as the parties may agree .' Welch v . Commissioner ,'204- :F .3 d 1 1 228., 1230 (9th Cir . ..2000) .(quoting Commissionerrv . .Valley Morri s 1305 .F .2d610, 618 (9th Cir'. .1962) affg .i T . C ., Memo . 1998- 121 ; see also Talmage v . Commissioner , T .C . .Memo . 2008-34 .' For a transaction to be a bona fide loan the parties must have actuall y intended to establish a debtor-creditor relationship at the tim e the'funds were advanced . Fisher v . Commissioner , ; 54 T .C . 905 , 909-910 (cid:127)(1970) . " Whether a bona fide debtor- creditor relationship ; exists is a question of fact to bedetermined upon a consideration of all the pertinent facts in the"case ' Id : at 909 . "For disbursements to constitute true loans'there must hav e been,,at .-the time the funds were " transferred,' an unconditiona l obligation on the part of the transferee'-to repay'the money, an d an .unconditional intention on the part of the transferor, to . secure repayment ." Haag v . Commissioner, 88,T .C .. 604, 615-61 6 (1987), affd .. without published ' opinion855 F .'2d 855' (8th Cir . 1988) . 19-- Courts have considered various factors-in determining- whether-a transfer . constitutes genuine indebtedness . No one factor is necessarily determinative, and the-fact-ors'considere d do. not constitute an exclusive list . See,El-linaer v Unite d States ,,470 F .3d 1325, . 1333=1334 . (11th°Cir . 2006) (listing a nonexclusive list,of 13 factors) ; Welch v . Commissioner , supra at- 123,0 .10 Often it comes'down-to a question of substance over for m requiring . courts to 'look beyond,the parties'- terminology'to th e -substance and .economic realities' BB&T Corp . v . United States , 523 F .3d -461, 476, (4th Cir . 2008) (quoting Halle v'. Commissioner , 83 F .3d 649, 655 (4th Cir .. 1996), revg . Kinastowne L .P . v . Commissioner , T..C . Memo . 1994-630) . Our-analysisof"the factors relevant to this- case , leads to the .conclusion that even thoug h the documents prepared by Derivium use the term "loan", the transaction -lacked, the characteristics of a true loan . The transaction was structured so that petitioner could receive 90 percent of the value of his IBM stock . Petitioner would have no personal liability t ''For example the,-nonexclusive-list of factors enumerated in Welch v . Commissioner , 204- :F .3d 1228, 1230 (cid:127)(-9th Cir . 2000), are : (1) Whether the promise to repay is evidenced . by a' note or other instrument; (2) whether interest was charged ; (3) whether a fixed schedule for repayments-wasµestablished ;'(4-) . whether collateral was given to secure payment ; (5) whether repayments were made ; .(6) whether,the borrower had a reasonable prospect of repaying the loan and whether the lender had sufficient funds to advanc e the-loan ; and (7) whether the parties conducted themselves as i f the transaction were a-loan . - 20 - Derivium, .,.and .it=would have made no .sense to do-so unless th e valueof the stock had substantially appreciated' .E : Petitione r .transferred-ownership of the .stock toDerivium,who . received al l rights, and . privileges , of ownership - arid : was ~-free to ' sell 'th e stock : sDerivium did . immediatelysell the stockand immediatel y passed,90 . percent ,of the , proceeds to petitioner' . . The only right petitioner retained regarding-shares .o-f,IBM stock-was an . option , exercisable ,'3 years later, in .2004 'to require Deriviu.m t .acquire 990- shares of,-IBM stock , and .deliver them'to h .im. in 2004 . . Petitioner' s . right to . exercise . this option in 2004 °was . 'wholl y contractual because he had already transferred all of'the z incidents°of ownership to Derivium,,which had immediately ; sol d the ... 990, shares . 11 See, 'Provost v . United States , 269 U . S 443 : (1926) .x ; Petitio-ner engaged in,,the'-transaction because he though t that the "loan" characterization would allow . him to r ealize 90 . 11In some instances Deriviumi's clients have requested th e return of stock . The parties stipulated that Derivium'- :s failur e to" return .the' stock has resulted in a number of lawsuits ; e .g . , The Lee Family Trust v . Derivium Capital L .L .C . , U .S . Distric t Court, District of South Carolina , Robert G . Sabelhaus v . Derivium Capital , U .S . District Court, District of Sout h Caroli na, The Ha mmond Family 1994, L ..P -v . Diversi fied Design , .U .S . District Court, District of'South Carolina, Newton Famil y L .L .C . v.. .DeriviumCapital ,~U .S . District Court, District o f Wyoming,, WCN/GAN Partners, Ltd . ,v .',Charles_Cathcart .U S .District Court,-'District .of-Wyoming, Derivium Capital L .L .C . v . General Holdings Inc . ., U .S .,District Court, District of South .' Carolina, Grayson . v . Cathcart , U .S~. District .. Court,' District of South Carolina . On Sept .,1,1-2005, Derivium filed a-ch . 1 1 bankruptcy : petition, and on Nov . 4, 2005,-the .case wa .s~converted . to ch . 7 and-venue was moved to South Carolina . Z k 21 ,percent of the value, of the . stock, whereas a ."sale " would hav e netted only 80 percent .of the.stock's value after payment of ta x on the , gain After the transfer petitioners-,did-not conduct themselves as if ; the transaction was a ,loan . Petitioners did not. report-dividends earned on the 990 shares of,IBM stock on their Federal income tax returns . When petitioners decided :not'to, , "repay the ;loan" in 2004, they did not ..report a sale ,of the stoc k on their .2004, Federal :income tax return and, 'failed to~ report an y discharge_of,<indebtedness income . .' This . failure was totally inconsistent with petitioners',, "loan" -characterization . As to .Derivium, immediately upon its-receipt of petitioner's stock,. it : sold the stock-in order to fund the "loan" . It did not hold,the stock as collateral for a loan . In an ordinary . .lendin g transaction the risk .of loss to a lender is that the borrower might not repay the loan . In contrast to the ordinary risk .assumed by a lender,, . .Derivi .um"s only risk,of . loss would have, . arisen if petitioner had actually repaid- .the " .loan Petitione r would very likely.have exercised his option to "repay the loan" if the value of the 990 shares of IBM stock, in August . 2004, . ha d exceeded the balance due . However, if petitioner had exercise d his option under those circumstances, Derivium would have bee n required to acquire 990. sha res of IBM stock at .a cost exceedin g the amount it would have received from petitioner . On the basi s of all of 'these factors we must' conclude that 'Derivium did not the "loan"" to .-be 'repaid ._-' O f course 'if the'=-value, been 'less -than the "loan"balance in 2004 , would have''. been,'foolish ."for petitioner" to pay t i loan " balance A petitioner .explained- at-trial,° he did not' 'exercis e his' right,'to ;'buy"back my shares " :(cid:127) beca u' se -it would have cost more =hold4,:Athat~the transaction~xwas =no t a iloan "and tha t :petitioner. sold ':his ,IBM stock .for $915860'2 3 This ~case presents . an issue ' of first impression in ;;thi s Court .° (cid:127)Howev .er,"4 -two other 3 Federal : count's=haver red'ntly . -considered : whether Athe =transfer of . (cid:127)securit 'es erivium under = its- :90-percent-stock=loan program was a7sale for Federal .tax purpos,es - . ' In each ' of those cases the courts , : ' a.singt ''es'sen ti'all y the .,,sam'e' fact s and 'applying the 'same legal' standards- that .'-are suchf . as' Grodt & McKay Realty., Inc ..' v Commis s' .ioner . 77'°°T1 .C .',ate 123 .7 .-1238 'and Welch A, v: . Commissioner , found, that °,thre .90=percent-stock loan'-program, . securities and-not , See ., Nagy" v . United States, 104. AFTR" .°2d 2009 :-778'9, '20'10=1 UST C (cid:127)12 As noted, by,, the . U . S . Court of .Appe als_ for the Fourt h e Circuit'when' it rejected the taxpayer ' s (cid:127)araument that- it had incurred a debt because the arrangement waslabeled .a ";loan" : "Iii closing'; we, are reminded of 'Abe Lincoln's riddle . many leas . does a . dog have if you call a tail a lea,?/'! .," United z is "four, because calling, a tail a leg does not make . ; itw one . "' . aa . tstsa~r Lorp ...; v . un .i-tea states , 5zj r' .,ja 4b1, . 4 i,i 2008) .; 2811 F 314 1108 1118 lf4-H iC 2002) 'Ti, .' "How .Roaers v . . (4tn uir . 23 - par . '50,177 (D .S .C. 2009) (in an ,action involving 'section 6700 promoter penalties, Chief Judge Norton for the-U .S .. District Court for the District of South Carolina granted the Government's motion for partial summaryy judgment, holding that the 90-percent- stock-loan-program transactions offered by Derivium were'sales of securities , not bona fide . loans ) ; United'States v . Cathcart , 104 AFTR - 2d 2009 - 6625, 2009 - 2 USTC ' par . 50 .658 ", (N _. D Cal . 2009) (in an action 'to enjoin defendants : from continuing to promote Derivium's .' 90-percent - stock : - loan program , Judge Hamilton of-the U . S . District Court for' the Northern District of : Californi a granted the'Government's motion for partial .summary judgment, holding that the .90-percent :-stock-loan-program----.transactions offered by Derivium were sales of securities, not bona fide loans) . Subsequently, the District Court-for the-Northern District of .California permanently enjoined Charles . Cathcar t 'from, directly or indirectly,, by us e of any means o r instrumentalities : 1 . Organizing, promoting, marketing, selling,,-or ,implementing the "90% Loan" program that is the .subject of the complaint herein ; 2 . Organizing, promoting, marketing, selling, or implementing any program, plan or arrangement simila r to the 90% Loan program that purports to enabl e customers to receive valuable consideration in .exchange . for stocks and other securities that are transferred o r pledged by those customers , .without_ the need to pay tax on any gains because . the transaction i s characterize d as a . loan rather than a sale ; United States v . Cathcart, . No . -~ 4 :-07-CV-04,762-PJHI,!(N . D ;;Cal ;. ;Nov . that Mr,. 4Cathcart stipulated to the injunction ., Derivium , a,magistrate judge ;for, th e the Norther n recommended that .;"injunctive relief . against :Dervum k -Revenue .United .States v . Cathcart , for :the enforcement ; o f 2010 .-1292 . (N .,,D . Cal . 2010), . Distric .t(cid:127) .Court . Judg e Hamilton- . adopted the, magistrate . ._judge' s recommendations ,findin g the ":report was well reasoneda.nd thorough .(cid:127)in every respect . . United States :'°v . . .Cathcart , 10 .5 AFTR;,2d 201071293 ( N=D,. 13The report and recommendation of ..the magistrate judge , which'wa ado tedb the District Court d : p judge, „ stat'~ e Section '74'0 .8 authorizes a . court'to enjoin persons who have engaged in any conduct subject to,~penalty ; under .§ 1 6700 if the court finds that injunctiverelief ' is appropriate to prevent the recurrence of- :suc h conduct . o'"establ'ish' a violation of § 6700',,warranting a n injunction-undera§ 7408, the government must prove tha t defendant' : ( 1)'organize d or sold, or°participated,in the organization or sale' of, an entity, plan, or r arrangement ; (2) made orrs caused to °be made ; '' false o r fraudu°lentstatemerit's'concerning the'tax°benefits to b e °der vedd from the entity ' plan, or arrangement ; '(3) kne w or had reason to know that the statementswere,false or' fraudulent ; (4) the false or fraudulent statement s (continued . . . continued ) 13 ( . .pertai:ned to . a wmaterials matter ;, and ( .5) an injunctio n .-is necessary qto prevent , recurrence of this conduc"t ' United States v . Esta te Preservation-Servs . , 202 F .°3d 1093,, 1098 (9th Cir . 2000),' citing .:I .R .C . 6700 (a)', 7408(b) . having some connection . to taxes can serve as a 'tax shelter.' and, will bevy an 'abusive',~tax-kshelter' .'if the defendant' makes- the> requisite . false'-'-or -fraudulent statements concerning 'the tax benefits of-' participation ." 804, 811 (7 h C r . 200.0) "Congress designed"'sectio n "Under § t 6700, any ",plan or., arrangement' Unit ed States v . Raymond, 228 F .3d .670-0 , as-a- 'penalty provision specifically directe d toward promoters of . abusive' tax shelters ' and other , abusive tax avoidance schemes .,'':' : United ..States .v . White , .769 F .2d 511, 515 ( .8th-"Cir .. 1985) (emphasis i n original ) In,, an order dated -September 22, 200 .9', the -distric t court granted in 'part and denied-.Lin,..par.t,'-Defendants ' motions . for, ,summary Judgment'- The :court found that the undisputed evidence revealed'-that4 : as part of-th e .loan transactio n. :in question ;: ' .legal' title of a customer'-s securities . transfers to Derivium USA-,(for example) during-the purported loan term in question, which vests possession of the shares in Derivium' s hands for the duration ., of at'he''purported loan- term ; tha t the customer must- 'transfer 100% . of .al°l shares o f .securities to Derivium USA, and- that-once-transferred , _Derivium USA 'sells, those- shares "'on the -tiopen' market, an d that once 'sold ., amount' to the . customer as the, "'loan"'. amount, keepin g 10% in Derivium USA's hands ; :-that during the term'-o f the loan,-the Master -Loan Agreement-provides : tha t Derivium USA has the .. 'right to y receive ' all -benefits tha t come from disposition of-the .customer's securities, an d that the customer is not entitl:ed .to these benefits .; that the customer, is furthermore prohibited fro m repaying . the-- loam amount prior .to maturity and'- is no t required =to pay any 'i ;riterest"'before the oan'maturi,t y date ;S and '-that', at the- end of the purported loan term , the ° custom er .is.-not, required- to repay' the amount= of the Goan (but-merely " allowed to do so - as one option at th e .Derivium USA .rtransfers 90 0 Hof that sale . (continued . . s (' .,. continued ) 'loan' s maturity date )°: and can exercise the -option :t o walk= away from the , loan :entirely at 'the maturity dat e 'without repaying the principl-e ; and thus,Yca n conceivably walk away ,from the transaction : withou t paying interest .r at ;a11 on the loan . 4The, following .factual' findings%arex .taken_; di:rect'y from . Judge . ,Hamilton '.-s' Order , dated . September Docket No . . 333 . Thedistr:ict court concluded that arialysiso _, , Inc .- :v.. Commissioner of Internal Re4drid6, these and other : undisputed ;:facts pursuant' to ;either th e benefits/burdens ' approach' outlined in Gr.odt & McKay Realty , T . C 1221, 1236 . (Tax " Court 19;81 ),, or 'the approach . I' outlined in Welch v . Comm r, 204 F .'3d 12281230 '(9t h Cir 2000), compelled the conclusion that th e transactions in question constituted sales o f securities, rather than bona fide Than transactions . See e .'a ": Grodt -, 77 T . C .- .'at : 1236-37 (applying°multifactor :.test to determine point at which : the burdens and benef its<°of'o ownershi:p are ,transferred '. f or.. qualifying-La transaction as a sale ) Welch ; 20A4 ' .F. .(cid:127),3d : at' . '1230 (examining factors, necessary ;to .;determine;; whethe r wa transaction constitutes- a ; bona fide,, loan) i. . purposes of ' The= district court, also found-that the, "substance, . - over form doctrine '' further supported-.theconclusion that', fn -looking beyond the actual language , Master Loan Agreement to .the -totality of thez~undisputed , facts, the substance of .the transaction' between . .the . parties constituted a sale, ;and not a . bona"fide .,loan'.' 'See e .a(cid:127)Harb or, Bancorp- and Subsidiaries 'tl,v . Comm'r , 115P F .3d .,722', 729 (9 .th° Cir . tax law follows substance and, not form -) ' :1997)- . (it' is(cid:127) ,axiomatic,,that . ., " , Reviewing the' above evidence and legal authoritie s , cited above, the Court concludes that, the-" evidenc e against'~,Defendant Derivium USA is strong',and .Y.that the' . merits .of the case: su ort ent r pp y of~default judgmen t here-, The , Court . concludes that an-, inj-unct'ion~yaga 'ns t (continued . . Securities securities lending .arrangement analogous to th e situation described :in Rev . Rul .-.57-451, .1957-2 C .B . (2) The stockholder, deposits his stock with his broker in a "safekeeping" account and, at the time of deposit, endorses the stock certificates and then authorizes the broker to "lend" such certificates .in the ordinary course of the broker's business to other customers of the broker . The broker has the certificates cancelled and : new ones reissued in his own name . n Rev . Rul . 57-451, s upra , the Internal Revenue Service wa s asked to determine whether the situation described above was a taxable disposition of stock by the stockholder . Petitioner s urge this comparison because the revenue ruling concludes tha t .there is no taxable disposition of stock unless and until .th e broker satisfies his obligation to the stockholder by delivering property that does not meet . the requirements of section 1036 . . Section 1036 provides for nonrecognition if .common stock . in a corporation is exchanged solely for common stock in the sam e 13( . . continued ) Derivium is necessary or appropriate for the enforcement of the internal revenue laws .. See e .g ., United States v . Thompson , 395 F .Supp .2d 941, 945-46 (E .D . Cal . 2005) ("Injundtive relief is'appropriate if the defendant is reasonably_likely to violate the federal tax laws again .-") [ United States v .'Cathcart , 105 AFTR 2d .2010-1287, at .2010-1290 to-2010-1291 (N .D . Cal . 2010) .] corporation . Id ., 1957- 2 C .B . at . 298 . ..a.nal'ogy, petitione r until 200 4 satis'facti'o n of his "debt "-,-to 'Derivium . The(cid:127) .transaction. differs significantly from that described i n the revenue ,, ruling . Derivium was 'not acting a s' i,,Ibroker , and th e arrangement between petitioner and Der-ivium wa's not,th e s.ecur -ities , len°ding k arrangement described , an, the- 'revenue rul ing . n the revenue ruling , the stockholder authorized his broker , subject at all times to the instructions-of the stockholder , "lend" his stock to others to satisfy obligations i n short sal e transaction . "loan" .in the revenue ruling ; required th e borrower, ' on demand ," to restore the lender .to th e same economi c position, that' he had occupied before entering into t 57-451, 1957-2 C .B . described the transactio n follows : In. such a case, all of the incidents of ownership . i n the :i'stock and not mere legal title, pass 'to, the ' ". :borrowing .' customer from the "lending " broker Fo r such incidents of ownership, the "lending"!', brbker_ :trha s substituted the personal obligation, wholl y contractual,_of the "borrowing" customer to restor e him; on demand, to the economic position-in (cid:127)wh 'ch=-h e 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 * * * . (1926 ) ,The securities lending arrangement des'cr-ibe d n ,Provost wa s on demand by' either the lender or the . borrower so that the lender 'retained . all . the-benefits and assumed al l burdens incident to ownership-of the stock . 1 4 The" masted agreement did :{not enable petitioner to-retain al l of the benefits and .burdens":.of-'being the owner-of the IBM stock . Neither petitioner nor Derivium could terminate the ."loan" on. demand . Petitioner could not -repay, the . "Loan and -demand return of his stock during the 3-year term,of the "loan" . As ;a ,result, petitioner .did .not, retain-,thebenefits-'and'bur-dens of ownership . He did not retain ,the ; benefit of - being :,able to'-sell- .his interes t in the ' stock at- any time during the = 3-year ' period and , therefore , could :not take advantage . of any :increases -in the stock' sp value . a t given time during the 3-year period . -At the same tim e 4In Provost-v . United States , 269 U .S . Court described the transaction as follows :, t 452,'thd Supreme During the continuance of the loan the borrowin g broker is bound by the 1-ban contract to give the lender all the benefits and the lender is-bound to assume al l the burdens incident toownership of the Istock which i s 11 the sub ect of the transaction ; asW though the lender had retained the stock . credit the 'lender. 'with the amount of, any dividends . paid upon the stock while the loan continues and the lende r must . assume ,or pay'to,r-'the borrower the' :amount. of an y 'assessments upon the stock . The borrower must accordingly 'The original short sale -is thus completed and there remains only the obligation of the borrowing broker, terminable on demand, either by the borrower or the lender, to return°the'stock borrowed on repayment to him of his cash'depo"sit, and the obligation of th e T lender . to repay ,the deposit, with 'interest ' as agreed . a - 30 - bore no risk of loss in the :'event'tha t value 'decrease d represented' .-by :Rev . .Rul. '57-451, supra , by enacting sectio n .Section 10 .58-(a) provides for nonrecognition of :gain o r when securities are transferred under certain-agreement s :n the case' of a, taxpayer, who' transfers securitie s * *"* . .pursuant to an agreement which meets th e ,requirements of subsection ( b) .,- no gain nor. . lloss ; shall be recognized on the exchange of such securities by th e taxpayer for : an_ obligation under such ,agreement, ',or . the, exchange of rights under such agreement by .that taxpayer ° fo:r .securities . 'identical to the- securitie s transferred by that taxpayer . Section 10,58(b) requires the securities agreement t o following four requirements in order to qualify for nonrecognition : SEC . 1058'(b) . Agreement Requirements.--In orde r to 'meet the, requirements of . this subsection, an : agreemen ,(1) provide for the return to the transferor of , securities identical to 'the securities transferred ; " "(2) require . that payments . shall be, made _C6',th e transferor of amounts - equivalent to .all interest , dividends,' and' other distributions which 'the owner o f the' .securities °is entitled to receive during the '=perio d beginning with the transfer of the securities 'by : the , transferor and ending with the t ransfer , of_.identica l securities back to the transferor ; -(3)-not reduce the risk of loss or opportunity fo r gainofthe transferor of the securities in th'e, (4) meet such other- requirements as the Secretar y may by regulation prescribe . The master agreement does riot satisfy the requirements o f sectio n 1058(b)(3) . agreement must give the, person who transfers stock "all of th e benefits and burdens of ownership of the transferred securities " and . the right to "be able to terminate the loan agreement upo n demand ." . Samueli .v . Commis sioner , 132 T .C . 37,'51 (2009) . Samueli we focused on . the meaning of the requirement in section . 1058(b) (3 ) [W]e read the relevant requirement * * * 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 ;secur.ity 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 * * * is a reduction in a taxpayer's opportunity for gain .. [ Id . at 48 . ] Petitioner was bereft of any opportunity for gain during the 3-year-period because he could reacquire'the IBM stock only ., a t maturity .. Schedule D that Derivium had'. th e [petitioner], to . transfer, pledge, 'repledge, hypothecate , rehypothecate, lend, short sell, and/or sell outright some . or al l also provides that Deriviurn "has the right to receive and retai n period covered by the loan", bu t fa e any. suchtransactions and tha t benefits during . the ter m 'return of any stock durin g the 3 -year period , his opportunit y gain was severely diminished . See Samueli v . Commissioner , Accordingly, we hol d that the transactio n analogous the .second situation in Rev . Rul . 57-451, supra, an d n arrangement that meets the requirements -: of sectio n -Section 6651(a)(1) provides for an addition t o tax where a Pursuant t o production fo_r any penalty, but the taxpayer bears , the : ultimat e burden' of proof . Higbee v . Commissioner , 11.6 T:. C . (cid:127) 438, 44 6 2001 Federal . income tax 1 section 665'f(a) (1 ) reasonable , cause .and the absence of willful neglect fo r failure - 33 - to timely-file . . See Natkunanathan v . ;Commiss oner ,'T .C . Memo . 2010-1 5 A delay in,rfiling a :Federal tax-'return is due'to reasonable cause ' :If,,the taxpay .er ,,exercised ordinary business .care and prudence and was nevertheless_unable,to,,f,i :le the'return within the prescribed time ;' .- ' Sec . . 301 : 6651-.1.(c)~(1) , Pro.ced .-' & 'Admin Regs . The . Supreme Court -has -said that willful' neglect,' in this context,-,means "a conscious,, intentional-.,f ailure 'or reckless' indifference .." United Sta t es .v . Boyle ,_ 469 U- S . 241, 245' . (1985 ) The only explanation :petitioner.s offered for. the delay in filing .-:their 2,001 Federal income tax -*-return -was .that .the y reported on their 2001 ;Federal income', tax mreturn . that they "pa .id $25,:150°1:in taxes., " -and ' .that. "without rechar-acterizing- the loan as a sale * * * j they] would have been entitled to a' refund* of' ..' $3, 979 ..- Petitioners' explanation 'establishes neither-reason able cause nor,, the abs.ence,-of' ;wi_llful' neglect . 'Accordingly ; we sustain respondent's' determination a'nd' 'hold . petitioner-s liable .for the addition to ,tax pursuant to . section '6651 .(a) (1) Accuracy-Related Penalty . Under Section-6662(a) ' Section 6662 (a)_ and, (b) .(1) and (2) . provides that a taxpaye r is liable 'for a . 20-percent'° accuracy-related .:.penalty 'on :an y portion of an underpayment of tax required-- to be shown on a', return attributable to, :: inter (cid:127) al-ia, ' (1)"} negligence or disregar d of :-rules or regulations ' or (2 .) : :a substantialiE understatement of Commissioner , 132 T .C . 161, 189-191 (2009) . The Commissione r bears ;the burden of production _ for'any penalty, but t tax-payer bears ,the ultimate burden of proof . Higbee v Commi :ssioner , .su ra at 446 .. .s'ubstant'ial understatement of income .taxi is, 'define d ",10 ; percent of the tax required to be =e shown on th e for -the .,t:axable: year ," or ".$5, 000 .-11- Seca ''6662 (d),(1) ( A as "',any failure to . make' a reasonabl'e . comply .,with the provisions of this :title" and , disregard includes "any careless, reckless, or disre.gard .= Sec,. :.6662. (c ) Respondenthas .met his burden of producti-on-b y 'that, . petitioner sold his IBM . stock . in 2001 and _failed 't o the .capital, gain . Petitioners' failure t o .the sale- of because the re'suLtant : .understatemen t more than ,.10 percent of the,co .rrect, tax? . The penalty under , section 6662,,(a) shall' not! be 1,-i m ;~any_portion of .an- underpayment where the taxpayer show s tha t acted . wi-th reasonable cause and in good . .faith,with, respec t such portion, . See sec . 6664 (c) (1) Higbee v . .Commissioner at, .448 The determination of whether a taxpayer acted wit h 'reasonable, cause and in good faith is made on a-case-by-case, - 35 - basis , _taking into -account al-l.> the pertinent 'facts-an d 'circumstances . H.igbee v . Commissioner , supra at 44'8 ; sec . . 1 . 6664-4 ;(b)- (l ) -," . Income Tax Reg s As previously noted, petitioners'.did .not .report their annua l dividends from their .IBM .stockwhic h were, under their version o f the transaction, credited yearly against their interest du e Derivium .- -A .payment of'the dividends by, IBM, under their versio n of the$,transaction,- would have created_ :taxable .income, to them . Further, in 20 .04 they , did not~ .report the sale-of their :-IBM stoc k an y gain . from that transaction,"~ nor,,did they report any relie f =indebtedness ih:come .'These .-:failures were inconsistent wit h some circumstarice.s, a taxpayer may avoid liabilit y showing reasonable relianc e competent . professional , adviser' .- Tigers Eve' Trading ;:; _L .. L . C . v . Commissioner ,' T .C . Memo . .2009-121 Boyle , .. supra at 250-251 .,, and Freytag v'.. Commissioner , ,89 T . C 849,- 888 (Fl987)," affd' . 904 F 2d 10.11 (5th'_ Cir . .. 1990), affd . 501 U . S . 868. ( .1991)) . .For relianc e on professional advice: to excus e the accuracy-related penalty, the . taxpayer mus t show that 'the . professional had fthe :requisi'te' expertise, as .- wel l as knowledge of the pertinent' . facts, to-provide informed advic e 'See' David~'v . Commissioner , ;43 F ."3 d 789-790 .(2d, Cir'. 1995;), affg .°<T .C(cid:127) . Commissionesupra : at . 888 ; Tigers Eye Trading,i L :L . C :. v .. supra . "The validity .,of the reliance turns o quality,ahd objectivity of professional .advice, which the y obtained :' .:'' Tigers Eve . Trading, L . L . C . - v . Commissi oner , supr a (.quoting Swayze v . United States ., 785 F . 2d 7:1'5, 719 (9th Ci r gibe-reasonable, professional tax advice mus t generall y from 'a of interest and not from promoters of the inestmen t 'Mort'ensen v .j . Commissioner , 440 F .3d 375, 387 (6th- Cir .'. 2006 .) , affg . Memo .. 2004-279 . :" Courts have routinely t'heid tha t could not reasonably~rely . on the - advice of.' :promoter s other",advisers with an inherent . conflict of int:erest',such financi=ally,~benefits from the transaction ."- Tigers Ev e Tradin L .L .C ., y . Commissioner , supra (citin g.-Hans en v . Comm-is'soner , ~ 471 F . 3d 1021, 1031 (9th Cir . 2006 ) taxpaye r cannot have 'a{°conflic t ,interest"), affg. . T .C . Memo .-2004-269, Van Scoten .v . ti C.ommissioner , . 4.39 F . 3d 1243, 1253 (10th Cir .. 2006) ' ('To .be °reasonable ;,the professional adviser cannot be directl y affiliated , with _,the promoter ; instead, he must 'be more . . independent"), affg . T .C . Memo . .2004-275 ., Barlo w 301 ., F,3 d,- 714, 7.23 (6th Cir . 2002) (noting "that courts have found -thata taxpayer-is"negligent t f obtaining-a n affg . . .T . .C . Memo . 2000-339, Goldman v . = 'Commissioner ; . 39 F .3d '402 , 408 Ci r .; °41994') (taxpayer could" .,not reasonably' -rely o n professional 'advice, of' someone -known to- ;be burdened with' .. a' inherent conflict of-interest--a sales representative of the ' transaction)-, affg .° T :C . - Memo . 1993-480, Pasternak v : Commissioner , :'. 990_(cid:127) F .2d 893, 903 _(6th Cir ." 1993) "(reliance' o n promoters or their agents i s unreasonable .'because'such person s are not independent $of -the investment)", affg . Donahue v-- Commissioner , -T .C .Memo . 1991-181, and, Illes"-v .'Commissioner , F .2d 163-; 166' (6th Cir . --1992) (findin g relied on person' with financials interest in 'the Venture'), affg . T .C . Memo "1.99I-449) "A',-promoter's self-interest- makes' suc h 'advice' ihherent1y_,,unreliable'" -.,Id . At trial petitioner testified that he relied on the advic e of- his 'finahcial adviser, .,Mr ., Talls' in' decidingr to enter into the transaction, . However, petitioners have not made any effor t to establish .Mr .Falls' credentials or qualifications as° a -financial or tax adviser ., nor have they established wha t .relationship .Mr . Falls had with Derivium, if any . etitioner .also testified that he relied upon :his accountan t witness .,; testified that Ms . Cooper-.provided-him wit h t'he ;,memorandum -dated December 12, 1998, from, Robert-,J .' Nagy Cathcar t 90% Stock Loan" . Mr . Cathcart was . .also Derivium'. s president ._1 5 Capita-11's .90-percent-stock-loan program was : .designe d create 9.6 nui-ne,indebtedness for Federal tax purposes ; P-etitione r 'testified that , he knew nothing about Mr .€ Nagy . other;than=that apparently wrote the 1998 opinion letter addressedto M r Cathcart concerning another 90-percent-stock-loan transaction . thelight(cid:127) . of the previously cited cases , we :(cid:127)'find tha t petitioners,have~failed to establish reasonable relianceupon competent ; professional adviser . Accordingly, . we-',..sustain. ' respondent ' s determination to impose an accuracy-related penalt y ;under section 16662,(a ) Inreaching-our holdings herein,, we have considered : all"_ ,arguments made and,,to the extent not mentioned-,-abo_ve,, w e conclude they,; are 15See supra pp . 22-23 regarding Nagy v . United States , 10 4 AFTR2d~'2009 -7789, 2010- 1 USTC par . 50,177 (D .S .C . 200,9) . y To reflect the foregoing, 39, - Decision will be entered under Rule 155 . Reviewed by the Court . COLVIN, COHEN,-' WELLS, GALE, THORNTON, MARVEL, GOEKE, KROUPA, _;GUSTAFSON,~ and PARIS ; J-J ,, agrees with this majority= opinion . , MORRISON, J ., didnot : participate in . .the consideration o this opinion . . HALPERN, J ., concurring in the result only .% := 40 - Putting aside the addition'to tax and penalty, we"mus t answer ,two questions . First, did petitioner dispose . of his IB M common stock in 2001 by transferring it to Derivium? 'Second, i f did, did the transaction nevertheless remain open,-for income tax ; purposes ; until 2004 when petitioner decided~ whethe'i to deman d ' Derivium . return _ stock i-dentical to ,the transferred 'stock, s o first question in the affirmative and the second in th e .as does the majority ; our reasons differ, however , answe r =Shares of stock of the same class are fungible , given rise to apparently formalistic rules for determining questions of ownership (and, by extension, disposition ) shar.es . :'The .traditional, multifactor, economic risk-rewar d analysis, as argued by the parties, is appropriate for , determining tax ownership of nonfungible assets , such as cattle . Grodt & .McKay Realty, Inc . v . Commissioner , 77 T .C-. 1221 , (1981) . For fungible securities, however, a more focuse d inquiry--whether legal title to the assets and the powe r Sec . 1036(a) provides : " General Rule . --No gain-or .los:'s' . shall be recognized if common stock in a corporation is exchange d solely for common stock in the same corporation, or if preferre d stock in a corporation is exchanged solely for preferred stock i n the same . corporation . .dispose of, them are - .joined: in the supposed owner--:has determinative of_ownership ' for more. Y . than : 100,years : In Richardson v- .' Shaw ,,, 209 U .S 365 (19 .08), a nonta x stockbroker, -,who held title to the securities ' in . a; customer,' s 1margin - account ,, .had .pledged those - securities :.t'o secure a loan The broker € then filed _ for bankruptcy .,--, The_ quest-ion .before the Courts was whether .,__ despite the pledge and the' broker's authority to cover -, itsobl i gation to its customer with securities othe r -,than those actually purchased on the customer's . behalf, th e customer was the owner of the securities and~ .so,_=on the broker' s bankruptcy., ., .did , not., become, merely=' ;a creditor . of the bankrupt . Focusing on t.he .fungibility ofithe securities in question an d broker's .limi'ted ,authority . to pledge ..them (and not to sell them except in ::limited circumstances) ., the'Court concluded that th e essentially -that, of :a pledgee and that th e customer was and remained the owner of the securities . Lega l title and the power to dispose were not united in the broker, an d the broker was"not, therefore , the owner of the securities . In Provost v . United States, 269 U . .S . 443 (1926), a Federal- stamp tax case , the question was whether the transfers of stoc k back and forth between a . securities lender and a securitie s borrower (both,stockbrokers .) constituted taxabl e dispositions of stock . ; The Court : assumed: that_ .such occurred- to . ~faci°litate short sales .~-~ The - 42 - provided ahe,stock to the securities borrower, who' .de'liverecl i t in fulfillment of the agreement of his customer (Who'-was-'shor t .,the s ,tock ), to sell it . The lender had the contractual -right, o n demand- (with notice), to receive equivalent stock from .'th e borrower ° ,~' .-The Supreme Court sharply distinguished 'the facts i n Provost ~from(cid:127),,those in Richardson v . Shaw , supra . .L .In Richardson , ~,the'llbroker.'s'~status as pledgee rather than owner rested on th e requirement that the broker have on hand for d elivery't c custoomers'c, stock .'of the kind and amount that the custome'rsgowned . securities loan, however : The-procedure adopted and the obligations incurre°d'i n 'sale neither contemplate nor admit of .the,retention,b y * * * the lender of any of the incidents of ownershi p in the °stock loaned . * * * Upon the(cid:127)physical', deliver y of the certificates of stock by the lender, with th e full .recognition of the right and .borrower to appropriate them to his short sal e contract, and their receipt by the purchaser, .all! th e ,incidents of ownership in the stock pass to . him . authority. of the ' , Provost . v .' United States , supra at 455-456 . Notwithstanding tha t the securities lender retained full market risk on the stoc k dispositions, shifting ownership of the stock transferred .- scholar wrote of the Supreme Court's analysis in Provost : The analysis could not be clearer : a pledgee doe s not e .become :" a tax owner of a pledged stock - while- a ~ borrower does become a tax owner of a borrowed stoc k because the pledgee has a limited control over th e pledged securities while the stock borrower's contro l i's, ;complete . This result obtains even though °a . stoc k borrower gains no economic exposure to the borrowed _stock, all . of .which is'retained by 'a lender : words, control overrides economic exposure i n determining tax ownership -of"'a borrowed stock . In . othe r Raskolnikov, "Contextual %Analysis of Tax .' .Ownership",' 8 5 Rev . 431,- :48 .1-482' (2005) (emphasis added) .. . Derivium was, iri the, position of . a ' ecurities borrowe r borrows stock ° to . deliver>- :on'-'a short ' sale ; 'and petitioner ' was' i n position of-the securit-ies,-lender who :lends his stock' to mak e It i's- enbugh ',f or me' th at petitioner 'gav e that de livery possible .,, Derivium' the ri .ght, ;and "authority to"° sell ''the ''IBM -common . .stock in, question ,for. its -own -account-, which- . Derivium ^in 'fact did . 3 The nonrecourse nature of,petitioner'sa-obligation"to'repay Derivium , almost every 'other -factor considered by the' majority- t o the point -Petit oner disposed-of the -stock in- 2001 . ' 2Professor _Raskolnikov builds' his ,analysis .; on xa. seminal . discussion of the fundamental difference between tax ownership of fungible and,, ..nonfungibleassets by now„ Professor Edward Kleinbard . See Kleinbar d., "Risky and Riskles .s Positions i n Securities 71 Taxes 783,-,(1993) .,. 3Apparently, . .Judge Ho^Lme's and ; I ,differ on whether .petitioner disposed'of his stock on Aug'. 16, 2001, when Morgan Keegan creditedDerivium's account . with the IBM . stock petitioner transferred, or'on the .next day, .; Aug .17, 2001, when Derivium sold that stock . Although I_,have--no authority-addressing that point, '1 think that, consistent .with~ Provost v . United States , 269 U, .S . . 443 (1926), petitioner disposed-,of the , IBM .-stock on-th e prior date ; i .e ., thedate he gave Derivium both' the right an d authority' to . sell the _ stock . ,.:- .I. do_, not ,believe that applying ,a similar rule ao transactions intended to be securitizations 1 1 , .,constitutes a-- change in ..the . law, as, Judge, Holmes : believes . Holmes op . note 1 . In . any event,'-sec . 1058 establishes a.,broa d 'safe-harbor to shelter many securitizations . - 4 4 Without more, that would constitute a realization even t tha t year . See sec . 1001 ( a) . Petitioner correctly makes , no . clai m that section 1058 .; saves . him from recognition of-Income . -Se e Samueli-v . Commissioner , 132 T .C . 37, 49, (2009) .-(sectio n 1058 (b) .(3;),.," requires that the lender be able to .deman d a promp t -return the lent securities ) . We need only determine whethe r .the calculation,-of gain or loss mu-st remain open, await-iryg th e determination-of+whether petitioner closed the transactio n i n '2004 by- .acquiring IBM common stock from Derivium . thin k not . Petitioner relies on Rev . Rul . 57-451, 1957 :- 2 C . B;. „:295 , wh ich addresses whether a taxpayer holding stock received -pursuant to the ;, exercise of a restricted stock option make s a disqualifying disposition of that stock when he{"lends" th e stoc k 0 4t roker in transaction that would qualify as a disposition -under th e analysis of Provost v . United States ,- supra . : Th e ruling concludes9that whether there is a disqualifying disposi'tion'turns"on whether, at the end of'the loan transaction , the taxpayer receives from the broker stock that would qualif y or nonrecognition of gain or loss under section 1036 . Th e pertinent fact s of the ruling are distinguishable-fro m 'the fact s of this-case because, in consideration for - his stock , t ,taxpayer in-the ruling appears to have received nothing other ' than "the personal obligation, wholly contractual, of th e 'borrowing'-°custbmer to restore him, on 'demand, t6 economic h :position in .which he ,,,would -have been . as'-,owner ,ofl .the stock, had the',loan .'., ztransaction not been entered into .-' Rev ., .-Rul- . 57-451 , 1957=2 .C .B . . at .297 . Perhaps the, Commi ssioner thought the' , ry transaction, remained .open because . of-,the dis .tinct,s possibilit y .:that, . .a;part .tf;rom ; the borrowing broker'- S,-contractual, obligation , the -taxpayer -would receive ; onl-y , stock that would---qualify any gai n (or loss ). for ., nonrecognition-,under section 1036 . Cf Starker v . ' . United States , 602'- .,F .2d' 1341 , 1'35 :5, (,9th= .Cir . ,19,79) (nonsimultaneous : transfer, quali-f .i.es as ;_,like-kind- exchang e ., .[e ] ven if ,.the-- contr:ac t right- includes the,- possib ility of the taxpaye r .receiving,somethin g other tha n ownership of like-kind pr,ope,rty")' . , ,The ... -ruling ;'may ,be o f limited significance for anothe r reason-,, .. since ,addresse s a. definition of. "disposition limited urposes,-., of determining whether, tthere-has been a : .di(cid:127)spositio n of stoc k received, pursuant .., to a-Fre,stricted,stock option .,,, The , rules governing restricted --stock ;: options, were found tin' section. .421 before its amendment by the Revenue Act of 1964, Pub- . L . 88 .- 272, sec . 22101 . 78 Stat .. 63, and subsection (d)(4) thereof defined . "disposition" as a sale , , exchange , gift, or transfer . of . lega l title but not, among other things," an . exchange to which section 1036 .applies . .4 The ruling contains insufficient analysis for me to extend it beyond its unique circumstances . 4A similar, rule can now be found in sec . 424(c)(1)(3) . Neither' rule mentions transfers of securities for which no -gai n is recognized pursuant to sec . . '1058 . - 46- IT'agree' with respondent that petitioner realize d di°sposition of the IBM comm on stock in 2001 . The partie s that the adjusted basis in the stock was .'$2l,'17 1 Resporident .ldetermined that petitioner ' s realized - gain, in ' 2001 , wasp $.72 ; ,435', ;because respondent allowed him to -deduct ' from th e amount realized not only his adjusted basis but als6f$10,- 3 ,,denominated in respondent's calculation as "cost'of sale ' Respondent further determined that petitioner must'recogn-iz e long=term capital gain) in 2001 . I agree that , petiti"over must recognize his gain in 2001 . It seems t o however,, thatthe "cost of sale", $10,399,probably represent s costTofithe sale but the nondeductible value-$of"the optio n that ' allowed' petitioner (if he wished) to buy 990" shares of -IB M cominon stock from Derivium in 2004 for $124, 429 plus,'" perhaps , -WHERRY,' J ., agrees with this concurring op,ihi'on . HOLMES , J : :; concurring " i A 7 - Derivium' agreed to' what Calloway claims was a nonrecourse "loa n secured? by his= stock .'- In exchange for money,- Callowa y transferred .acontrol of the' stock to Deriviuin . Derivium sold the stock on the open market . (cid:127)Th e apply . Section 1 .10.0 .1-2 (a) ,(4) .(i) :, ',Income Tax Regs . provides that "the , sal e * * liability Commissioner''v . Tufts", 461, U .S . 300, 308-0 9 Commissioner , ' '331 U . S . 1, 12=1' 3 realized includes 4any1'nonrecozrse liability secured' by the ' property sold . Calloway would- then have to-recognize the difference between- the - discharged debt (i .e ., the . amount of the loan- .proceeds p1u one day's accrued iiiterest minus--hisbasis i n the stock) " That would be enough to-solve the this- case ." The majority (admittedly a behest)- :instead- goes ; off on a frolicand~detour through a n inappropriate'multif.actor test,"oapplie s ends . up reaching' an overly broad-holding with potentially harmfu l effects-on other °areas -of law . .,The ,key : mistake the-,majority-make s ransactions as one . =,These'~-two' transactions purported - 4 8 loan'as .set .,forth in the Master Agreement and Derivium! s secret sale of Calloway ' s stock to an unr elated party . they characterization of the first transaction- ,the=or e_ tha t Calloway actually knew about because he signed the .Maste r :Agreement --that should . be our focus . The subsequent sale,- thoug h 'it,'must .be analyzed for its own tax consequences,j,,should', -no t affec t our : characterization of the purported loan-Accor d v . Derivium Capital, LLC , No . 02AS05849 (Cal . Super . Ct 12003),("While the immediate liquidation of the secu.rity_-may=hav e many , untowardimpacts upon the parties to the transaction,, thos e potential impacts have no apparent relevance to,the„.bona fid e majority concludes that the initial tran sfer, of stoc k sale without ever findin g that Calloway knew that Derivium would sell the stock ; . « ; collateraizing the loan . Its holding is that Derivium' s to sell was a :sale . Collapsing Derivium's contractual'righ t into the subsequent sale would be appropriate if .'Callowa y ,was splintering one transaction into two for .no other purpos e than . to .avoid ,. taxes--where the transactions were otherwis e interdependent, and focused toward a'particula r Pierre v . Commissioner , T .C . Memo . 2010-10 6 step '', transaction doctrine) ( citing Commissioner ,y .FaClar k U'. S . .72,6, - 738,:. (198 9)) . But here, where Derivium,represented , to that itvintended to .hold :the stock and never,-,tol d them of, the quick sale, one cannot . say. that these transaction s were integrated . or .-interdependent, . .IL . -arrive at it .s-,,destination', ;, the, majority uses Grodt~, & 'McKay Realty, Inc . v . Commissioner , 77r T . C,.. 1221 (1981) . Grodt & McKay., we.:thad- to distinguish between a . sal'e and -a sham involving- ,the purpor.ted, sale . !of cattle' . Ina this case, :the : parties aren't arguing , about whether there was a ,sale= or a -sham, but about whether(cid:127) there' was a sale . or, .a loan . If, we are going t o compare apples .to oranges,,we could just as . easily use the tes t for .: ddistinguishing a loan from :;compensation- in Haag .v' . Commissioner ,' 88 T,;.C . 604 ; :. 616 n ..6,-(19.87.) , affd .- withou t published, opinion 855,; F 2d 855 . (8th Cir . 1.988 ), or the . test for distinguishing a loan from stock redemption-in- Rogers-v .' Unite d '281'F .3d 1108 (10th Cir . . 2002), 'but 'those tests, too , containT'irrelevant a essence of the distinction we need" to-'make in this case . Grodt & McKay is , just the wrong test for analyzing 'this " transaction, . , borrow from tests that may b'e,-otherwise inapplicable,if .we Memo . 1998 -121, for - 50 - example a,set s out the defining characteristics,of : seven Ifa'ctors that courts have considered , none o f which woul d 'have to .'be dismissed as inapplicable to this case . A good test should also reflect the nature of the,propert y involved to;.determine the relevant factors, the 'proper "weight fo r factor,' and whether any additional factors-would' .:be :useful . 'See, e :~g . - Torres v . Commissioner , 88 T .C . 702, 721-22 . (198 7 20.03 -7 2003 - 1 C .B . 363 . The majority starts=down-th e ;right 'paths by ,excluding payment of property taxes' as' a ownership'°( recognizing its inapplicability tos€bck) , 7,,but then it stops short, not analyzing th e significant' :differences between the fungible an d property'at'issue in this case and the nonfungible ;..an d tangibl e ~property":;at issue in Grodt & McKay .' One would think " Judge Halpern does recognize this important difference, an d (following some quite persuasive commentators ) urges "1us .to'adop t "control' :' as .tne essential attribute of determining thew,ta x ownership of'securities . See Halpern op . p .'43 . In ,' ;host al l tax .contexts, the concept of control as the touchstone'of,, ownershipseems much better than the ever-pliable multifactor' tests : that dominate .the field . I also agree with . him that i t Of fers ,i" much better path in explaining the casela w',''at least ' before today's result . But it does not adequately-distinguish , as I"explain below,"between secured interests in stock "an d outright . transfers of ownership . Maybe it makes sens .e,to,, _ 'obliterate 'this distinction, and treat all secured interests in securities as,sales if there's been an effective change i n control over them, but that big a change is one for th e legislative branch, not us, to make . In the meantime , we,should do our b es.t°, to come up with a way to distinguish secured 'loan s from~sales even when modern conditions make the distinctio n 2 (continued . tha t iskn't,, See,,:; e . g , United : -Natl . . Corp .°. v . Commissione r , 33 B .T .A . 790 ( .1935) : (findingp-_ .a4 100-percent loam on the, value.,-ofstock , characterized ;by-the'participants as a sale, was 'in fact a loan) . ; ~Fisher V,. ¢Commissi_oner , a loan) . The Gr.o:d.t- &- McKay ;tes, might :be helpful . i141 the majority . adapted I o match the actual- facts:,of-,this . case =.instead_, .o=f° 3 applying, it without consideration ofr how, shares of .. stock d rfrom ;.livest :ock rvand" how3 dist hgu skiing , a loan 5;from a' sale-, i different from .d stinguishing -a, sale .from : aM:s"ham . ...Consider: : Title - and, Possession ?.„ The 'clumsiness , of ., using . Grodt & . McKay most stri~ki,ngr,in its -,-focus< on' title> and' possession . Thes e factors ,don't 'jibe well, tw th .'the way stock isY actually: held . far-,=back- as 190 .8, e in, .Richardson , v .,.° Shaw ,t'(cid:127)the' Supreme Cour t realized that a shareholder :could retain ownership without titl e r 'possession when a, .broker purchased and held the shares for th e shareholder' s . account : [ I ] n' no just sense can the broker be held t o be they . owner of. the' shares 7of stock which he purchases anVd ' carries - for his ' c'ustomer . * . 1 ( .. continued ) sometimes hard- ; to - figure out' . - 52 - * * * * Upon settlement of the account * * * [the broker ] receives the securities . In this case the broker . :,assumed 'to pledge the stocks * * * because by the .°terms of the contract * * * he obtained the right from th e customer: to pledge the securities upon general'lo'ans, ' andinlike manner he secured the privilege of sellin g ,Vwhe.n necessary for his protection . ' 365, 377-78 (1908) . Stock ownership today is even farther removed from =tangible- property concepts like title and possession owing to the rapi d evolution, of the indirect holding system . The official'!'titl e holder of°,most publicly traded securities, and . possessor ; nphysical ;-stock certificates, is Cede . & Co . --"thenominee ,used'. by . ,The Depository Trust Company ("DTC") , a limited' purpos e trust : company organized under New York law for the ;purpos e acting, as-, a depository to hold securities for . the benefi t pa-rticipants, some 600 or so broker-dealers and banks ." " art . & ((cid:127)1 .994 )y -(prefatory note ) . The U . C . C .' s drafter s that somewhere between sixty and eighty percent : of 'publicl y ZThe American Law Institute and the National Conference o f Commissioners on Uniform State Laws have often had to revisit : th e ;problems caused by the rapid changes in the securities"industry . Their' most recent revision of Article 8 was "to eliminat e uncertainties by providing a modern legal struc .turefor'(cid:127)curren t securities holding practices," U .C .C . art . 8 (1994 .)a(prefatory note), and "to eliminate the uncertainty and confusion that5,. results from attempting to apply common law possession concept s to ,modern securities holding practices ." .*7 . It would be wise for courts in other areas of Taw'= to acknowledge these parallel efforts to accommodate changes - in,the r'e'al world . Id .' sec . ^ 8-106 ' cmt . T - .5 3 <_ traded securities' : are held ; by ;th e brokers" and banks -tha t participate§ in' t he .DTC .3 ::f brokers . "sells stock- to a, purchaser a purchase and sales are netted taga.ins t und'erlyi ng" stock remains in Cede & Co, . -S name . See id This means t'hat 'e.ven 'when. ",ther e isant =undspi'ted 'sale 'of' stock' th e title holder'; often' does not change . '' The inaj "orty concludes tha t legal title ° p'assed' when Cal loway "t,ransfe±red the IBM stock' t o Deriviun'<s Mo-rgan Keegan. accoun t if ' the" "IBM, shares traded 'stock s - :then titli~'-didh't-°' actually'' change . The'-right ° of possessioriwsimilarly'makes some"sense whe n talking' of cows . The= owner of a"cow 3is ' likely to be able 'to' pu t it ,.'in ,the barn of his' choice ; but,_ possession is unhelpful ' t determine'- the ° owner = .of shares';of-(cid:127)x stoc k { 33The' DTC~ Is -now a_,-'subsid ar(cid:127)y 'of the Depository & Trus t Clearingv Corporation' " whi"clz sells :even more ,clearinghouse services wThe scale of"the 'transactions roiling beneath th e placdtsu'rfac'e =of stable title and possession is mindboggling-- annual volume' is= measured 'not- in ; trillions ;-' but' quadrillions o f dollars : -"'The Depository°"T .rust'& Clearing Corp ., About DTCC , htt -p :v//www -."dtcc : com/about / business / index .php; Securtes "°and ,xcnange- (_ommission,= zesrirnon y.- rtegarai:ng xeaucing x sxs an a Improving O:ver'sghtixi' the. 'OT'C ."Credit"Derivatives 'Market',Befor e the Subcommittee on Securi ti°es',' ,Insurance , and, Investment of th e ..Senate--=Committee on Banking,Housing, and"Urban Affairs ;"James A . Overdahl''-Chief„ Economis t'uly'' 9 2008 ) ; available a t http :// www .sec . gov/news / testimony / 2008 /-tsO7090-8ja'o(cid:127) :htm . - 54 - in stock is no .longer delivering a physical certificate or, ;°notiri g the 'pledge-o n on the books of the issuing corporation ;,„it s contracting with a lender who is (as a matter ofr'contract ) allowed to sell, . .repledge, relend, etc . the stock involved'. the U .C .C ., in fact ; a lender with a,secured interes t of . stock must obtain effective "control ,over,themat o maint(cid:127)ain^,priority--that is, he must take all .steps . ;so,tha t sell :the secur.ities without further permission of .the borrower. Id . sec 8-.106 cmt . 1 . One accepted way to obtain control i s have the borrower transfer his position to the lender ;, onth e books of the securities issuer or broker . Id . sec ;. .8-10,6 (d) ,,(,I) . or the . rest of the outside world is concerned,, the, securedv ,part y the debtor remains the owner as between him and the--secure d "Consider the following language, often found in margin account agreements, where the Borrower gives the-Lender"the-righ t to ".pledge , repledge , hypothecate or re-hypothecate, withou t notice : to Mme, all securities and other property that,>yoiu u hold ; carry or.£maintain in or tor any of my margin or short Account s * *', * ,without retaining in your possession or under, your,-,contro l ;for delivery the same amount of similar securities ,, or : othe r property. The value of the securities and other property tha t you,maypledge, repledge, hypothecate or re-hypothecate mayb e greater than the amount I owe you ." TD Ameritrade, .,Clien t r,Agreement ;,;http ://www .tdameritrade .com/forms/AMTD182 .pdf ; se e also Pershing, Credit Advance Margin Agreement, . .https // www .uvest . c o' m/pdf /Margino20Accounto20A.greement =..pof ; .Zecc o Trading ; Margin Application , https :// www .zecco . com/forms /marginapplication/ DownloadForm .aspx . 55 party . .'.- See-id . sec .- .9 -207),'cmt 6, Otxample) ,x'(2000) . This, makes secured-lending collat6ralized by securities look . very similar t o a sale if :.rmeasured= by title and possession = . .; S'e'e, e . g . id .- sec . 8-106 . :cmt" . ti4 Obligation : to Deliver Deed . Perhaps the most striking, proo f .of the inaptness"of ' Grodt"& McKay for this-,-case- is its' attention to "whether' the_c&ntractt-C' .reates,a_present' .-obligationon th e seller 'to execute and' deliver a deed' 'and' a- present' obligation' on the . purchaser, to "make payments . Grodt''&' McKay , : 77 T .'C . at', 1237 . The. majority construes ' this ° :to mean- an, obligation by Calloway ' t o transfer scontrol~-of his stock'and -of<°De,rivium to transfer money . Maj ority.' Op .. ;p ;.:, A 'focus _on whether there are curren € obligations to =deliver 'and pay=mak' " perfect sense in distinguishing 'b'etwee'n a(s l'e of-' cattle and a--sham'transacti"o n As between those two characte°riza .tions,-'if there is 'a current- ,: fobligation'-, to exchange money=°-for possession,"of cattle the 4, " transaction is° More- li'kel'y ai~sale . But this' factor onl y shows ..how (cid:127) £Littl e use ': the ' Grodt' &<° McKay test"can be h distinguishing loan from-a sale where there is of, course-,,an obligation ' for 'Derivium -to transfer money :- that's"the whole'point of a-,'loan . '.'And- every' pledge ;loan'- includes a t'rans'fer ofr'possession of a 'chattel (i .e ., collateral)'.'Thatdo'esn't' make'pawnshops the 'buyer(cid:127) s t of every :. bit4 of their collateral See, '' . e : g .' R . Simpson & Co . 'v : Commissioner , 44n B'T .A '498 ; 499~a('1941) (noting hat - 56 - pawnbroker's business was lending money o n personal tpropertyy 128(cid:127)F .2d .742(2d Cir . 1942) And i n ofstock, : iwhere.the,concept of possession has become so illusory ; ,the , usefulness of execution of a "deed" seems even less, helpful tha n the concept of passing "title" . The, rest of the factors don't much help either :,. Whether an Equity Was Acquired in the Property . .u_The,- majority , „refe-rs to this as "Equity Inherent in . the, ._,Stock " majority op.. p . 16, but it isn't clear what "inherent or how .that concept would apply to stock, which , is .notonl y intangible and fungible, but divisible . As used in Grodt :-&: McKay,,this factor describes not rights, but value . Grodt, & McKay , 77; T ..C . , at 1238 ("Petitioners ostensibly paid . $_6, 00 0 head for : cows . they knew were worth far less and which , ,we find ha d a*fair market value not in excess of $600 per head . ), : y anything,?this ;suggests that Calloway retained anequity -inth e stock for .the short time before Derivium sold-it- After all-, gotonly,f90 percent of its fair market value . And in finding;-: that, this factor weighs in favor of a sale, the ; maj ority .1 state s that .the effectiveness of the arrangement depended on Derivium' s ability to acquire and deliver the required number o f 2004 but,fails .to note how this is inconsistent withna loan-th e success of every term loan depends on the ability of th e to perform at the end of the term . (It also assumes tha t from .,. - 57. Calloway' s perspect"i}ve,',=Derivium wasn't 'going to keep th e collateral iii its' accountand he'dge against- fluctuations in its value )L w x: "Perhaps the maj ority 'int'ends, _ toy suggest that ' there is a due . diligence '-requirement ori- the art of the borrower that, ' -wa s p not completed . here . ~~T hs't :nakes' sense ---an apparent inability to return, collateral -'re a . p y a ' loan °"' - , or fund" a loan in the firs t place -would weigh 'ageirist findingL the -par'ti'es truly' intended a loan, See, e . oul'dman v . ommissioner' ,- 1 65,-F .-2&-686, 69 D (4th Cir 194'8), ':affg . a ;.1'4emor"andum Opinion of this'' Court' 'Bu t there is< .nb explanation o ,this)-poin and 'n o indication whethe r -there was - anything Y'at the lime tha t sh'ould'' have-warned Callowa y that Derivium would not be able to perform . "Risk of "Loss 'and 'Re e.iI'ot,j of Profits 'From'-the Operation an d Sale°' of the . Property . In°' today'-s" world ,",when, deal'ing(cid:127) with' ' intangible, r'fungible, .;se'cur :ities, i- agree with Judge .Halpern tha t the' benefits"and-burdens'of ownership are "beside the point"ti n determining whoj is -the ~ owner 'for' tax purposes . Halpern op . ' p: 43 Stock .:-owner : s . who:,- want" to 'keep~ ''ther stock but hedge agains t risk or sell :benefits ' have 'long~ h' ad various ' methods available' t o trade away ''theebenefits and burdens, of owner ship 'withou t affecting tax-bwnersh'ip : See' Kle nbard "Risky and'Riskles s Positions in Securities," 71 Taxes 783, 786 (1993) ("The economi c risk/reward analysis .applicable in determining tax ownership' . under a sale-leaseback of a building or other tangible propert y is,,difficult to apply sensibly in the context of,publicly,trade d securities .") . In some cases , "the traditional determinatio n bears market risk is more than simply not dispositivei t negatively correlated to the tax conclusi .on-:",° Id . This is consistent with our correlative holdin g option 'to, purchase stock, even though entitling , .the .holder -to th e benefits,, of appreciation, isn't a present interest in :.stock Hope v . : Commissioner , 55 T .C . 1020, 1032 (-1971), affd,% 47,1 = 7;38 (3d, . cir . . .1973) If the majority's analysis is applie d broadly., , stockowners will be surprised to find out thatt they( unwittingly sold their stock by engaging in common , hedgin g transactions . As a practical matter, the majority also seems t o that . Calloway bore the risk of the first 10 percent . of -.loss--.in' realized only 90 percent of the stock's--value-,in--,2 .0,01 .. . appears to treat the remaining 10 percent . as the-price--of an option (used colloquially, rather than as a derivative instrument , theysort traded in the options markets) . The majority als o „glosses, over the fact that Calloway theoretically retaine d of the stock's upside via his power to repay the loan for , return of ; collateral coupled with his right to dividend,payments . 5 9 The - . majority' approach .-has the po,tgntial to wreak some ., ,havoc, on the,, unsuspe+cti ;ng . . For ,instance,- the, majority ; seems-to say that a nonrecourse .loan, -that is, a loan where the borrower . has the option to .. -surr-.ende .r,-col1ater,al, instead . of repay--does' no t include an obligation .to .repay . Parti:cularly .relevant here, .th e majority notes that for a loan to ex,ist_, "there -must, have- .=been,, at the time the~,funds were-,,trans_ferred,, an unconditional obl,igationLL on ,the part of ;the .-,transferee to repay-the money,' and an : unconditional, intention on th .e part of the transferor to .. secure , repayment '," Major- ty op .,.,- p .;, ;18 ..(quoting Haag , 88 T C . 615-16 The' majority, ;continues , ".Often it',come .s down, to - a questionkiof substance over, form requiring courts to, look beyond the parties' terminology' to the substance and economic , ,-realities . if Maj ori .ty op-.e p, --19 . ,; ? From-.there the . majority ., :concludes -that°,the :trans.ac-t .ion la-cked, the characteristics of 'a true loan :because ",[p] .etit_Loner. ,wo,uldk have no, peraonal liability to-pa y principal or, .interest, ;-to ,,Derivium, and it would have- .=made no sense to do so,unless',the value, of the stock had substantially app,reciated ." Majority op ., pp' 19:-20 . . - That .'s-way=t(cid:127)oo broad a statement of the law if taken seriously . Before this case,nonrecourse loans have satisfied the obl gation-to-repay test if, at the beginning of the loan, it 60 - , .would make economic sense for the borrower to pay it off . Tufts , 461 U .S . at 312 . In other words, if the loan i s overcollatera.li .zed at its inception, courts find' an''obli'gation repay °and :a- reasonable prospect of repayment . See Odend' hal 'v ... Commis"signer , 748 F .2d 908 , 912 (4th Cir . 1984 ),, affg .*80 T .C . , 588' :(198 3,) :. . Events that occur after that time are immaterial" t i this ,initial characterization . See Lebowitzv . Commissi"one'r, 91 7 FY2d"1314,' 1318 (2d Cir . 1990), revg . T .C . Memo . 1989-178 . the facts "of this case , Calloway-- whose loan was- overcollaterali.zed by 10 percent--had a bona fide'obligatibn . repay .:- Nonrecourse financing is a perfectly normal . pa'rt- .of th e busi'ness ': world . See Robinson , "Nonrecourse Indebtedness" "il }11 .°..Va . -iTax-,Rev, . 1,, 10 (1991) ("The legitimacy of financing' wi=th'~ ' nonrecourse indebtedness is widely recognized") . Some state s have nonrecourse financing for residential mortgages,- e . Civ . P.roc .'Code sec . 580b (West 1976 & Supp . 2-010) an d the-,-entire pawnshop industry is built on it . See-Nat-i,ona l Pawnbrokers Association, "Pawnbroking Industry Overview" "(200 8 09) ; , available at http :// www .nationalpawnbrokers ." org:/fil"es(cid:127) /" Industry%200verview%207-7-09 .pdf . A general statement-abou t unconditional obligation to pay as a key characteristic is shouldn' t be read to -''say l that . suc h financing isn't, a speciesrHof ~loan' . - 61 .., ' B . A second, . way in. .which ;th e ;.'that "it, implies, that= g .ivi'ng a~secured 'lender the right to . sel l underlyingx_st:ock without no tice , .to °th.e . borrower turns a loan-, int o a- sale : .°<. But . this is ,commo n "Some =investo rs have' been shocked to- find .out that- the' brokerag e firm has the.-right to sell thei"r se'curi 'ties that were bought r' o n margin- withoutYany.' not'ificati'on, if Exchange= Commission, "Mang Ln : Borrowing, Money To' Pay for Stocks" , Atwood V . Commissiorier,'T' .C . Memo . 1999-61, is a 5A common instance .of'this is borrowing against the value o f life-insurance policies .The tax treatme nt of this phenomenon is easy to understand and, ,(one : hopes, . even„ after today) settled as a matter of''law . good example . In 19.86- and, 198,8 the Atwoods,, purchased single-premium life insurance policies . After experiencing some financial ...difficulty, ,th'ey decided .to . borrow, against their policies with loansLL . rom'the'insurance company . They received . cash .' immediately and tax free . loan plus interest, walkaway by surrendering their lif e insurance,,policies, or (by paying--the premiums) = keep the loan o itstanding ':until'-, the ' poliOy, paid out at Ay thteirR death . .. .They had .the-option to repay th e The Atwoods didn't pay premiumsor loan' 'payments, so th e ' insurer allowed the loan to_remain .outstanding .until ..1.995, when its .balance reached the policy' s cash surrender e ., At tha t time the insurance company,cashed ..inthe Atwoods' .policy, .but . instead of 'sndirg: a check to them, it . paid itself back-first . Because this payment otherwise would have been, a- cas h distribution to them, 'the Atwoods were charged with income whe n the-loan : was , repaid ;with -tl eir policy. p.r-oceed"s ~ The lack of :an enforceable ..obligation-.to repay-=beyond surrendering pledged' . collateral -ddnt urn the initial transaction"'int'o a . sal e instead of'a loan . I . - 62 - http :,/./ www .sec . gov/investor /pubs/margin . htm ; see als o And the majority's holding is also inconsistent with, :Eth e current form of most stock ownership . In the case o f -held through an intermediary such as Cede & Co ., :the ;,U .C . C refers-to the stock owner as the "entitlement holder" : and refer s the interest in the stock as the "security entitlement . U .C .C . .sec,. 8-102 (a) (7) , (17) (1994) As discussed . ; above,, ift, a stoc'k;~,owner--.or "entitlement holder"--wishes to borrowagains t his-,"security entitlement," the secured lender must tak e "control" . to maintain priority over other creditors '. : Borrower s .can-.:give a(cid:127)lender control by transferring their position ,to the : lender on the books of the securities intermediary,- id sec . (1), .or by arranging for the securities intermediary .t o actonrThstructions directly from the lender, id . sec . 8-106( d)(2) . In essence , a lender has control when h e whatever steps are necessary, given the manner in'which th e securities are held, to place itself in a position where'' i have th'e .securities sold, without further action by'th'e owner . Id . sec . 8-106 cmt . 1 . Therefore, a secured lender customaril y has a contractual right to sell without notice or demand , ..an v ." Firs t 6Even under the majority's analysis, giving another,,part y the right to sell is not always a taxable disposition . --If->th e ' parties't,,agreement follows the guidelines in section l058 ;(b)4 :,the n (continued ., .) Opti=on-s -of, Chi . 3-Inc . , ' 143 F .3 d 8Q7,;,,. _818 -,(3d Cir . 19'98 ) (then-Circuit .Judge' Alito) holding-=wha t money nwa.s nonreco:urse . and ''Derivium' -had . the : authority to sell ' after . taking possession-, of the -stock ._ Given modern conditions i n 'which, a ' .lender' s .'authority - .toysellt stock -is routine and eve n necessary ., the real : effect: of the holding would be to° treat al l noncecour"se :' lending, against' .stock collateral as sale"s . The majority, does:, not appear to . realiz e how startling'(cid:127),that , woul d J V . The Grodt :~& McKay- test ; = like-Fother- .transaction"tests,' als o notes that , the intention-; of .,wthe parties 'governs the true nature 6 ( : . continued ) the Code says no, gain or loss need be recognized by-the stock . owner at the time of the initial transfer . _'Sec'. 1058 ( a) Thi s section,, generally is applied-to allow margin brokers to-engage i n short ' sales without tax' coiisequences to the stock owners . Section 1058 would mitigate-the effect of the majority' s holding, if the right too sell was commonly limited to . short ..'s .ales or other transa°dtions that fit'into the confines of section 1058(b) . But as, discussed above,, stock ; owners,: also customarily give a secured lenderthe right to sell for the lender's ow n protection--e .g .,,,to, cover margin calls, or repay a .loan in ,default . If a secured lender sells the underlying stock'for on e of}these. reasons, then any. obligation to_return.identica l securities is typically replaced with an obligation to apply th e proceeds, of the csale „to the outstandin debt- - .See, e .g ., . U . C_ C . s protection of ,section . 1'058, initial transfer'-taxable' under the ' m' ajo-rity'- s analysi s ec :'9 =207 p he transaction from, th e see ff sec . 1058 (b) .(1) , and renders the (c) (2) (2000), . This rips he t 64 - of a transaction . Grodt & McKay , 77 T .C . at 1237 ;, seeMals o Welch , 204 F . 2d at 1230 ; United Natl ., 33 B .T .A . at-"7. 94";,i Fi'sher , 440 ., Intent is seen by courts "as evidencedby the " written agreements read in light of the attending fact s circumstances Grodt & McKay , 77 T .C . at 1237 (citatio n omitted) . If the test is stated that generally, no one can ' disagree . :But in addition to the problems caused 'by .' :this4 tes t this : case, . the majority does not analyze the effect of . deception . .. We are confronted here with one party who was not .;being'ho.nes t .,withthe ;other about its intentions . (The Commissioner admit s generally that Derivium told its customers that it intended,to ' hold,.thestock and hedge against the upside risk via a- .,proprietary trading strategy . Reqs . for Admis . 264, 276 .)ra „ Despite the importance of intent in these tests, the majorit y doesn't address what effect deception has on .the characterizatio n of .th'e 'transaction . eception'should have been considered at a minimum under the t Grodt & McKay factor regarding the parties' treatment of th e 'transaction, but the majority merely notes that the, parties ' treatment was inconsistent with a loan because uallow a that he knew he had authorized Derivium to sell his,stock knowledge, however, is not inconsistent with a nonrecours ,;loan . e secured by fungible collateral--such a provision is,standard brokerage .and custodian account agreements where stock"secures a See - supra' note-4'. The majority fails to mention tha t ' .Calloway. testified .that ." he .(cid:127)"did,not know Derivium had sold the " quarterly' lies that it stil l -held the collateral 'and credited .the amount of-dividends'paid t o reduceCalloway's ;interest oblig=ation : That, too,=however, wa s part of the .'-conduct of{ the partie s The majority' Simi{larly notes that, Calloway was never required- to . .-repay- any principal 'or interest, but this also is ., consistent wi'th the : loan terms-'!-- n onrecourse loan with a'ba'lloo n payment at the 'end . .' We have = recognized' . parties' rights t o structure loans'Eas they se e fit, : even allowing- for- zero interest . ' Welch -, 2-04 ,"F'.3d& at 1 .230 '(quoting' Commissioner-,v". Valley Morri's Plan , 305 F .2d 610, 618 (9th% Cir . :1962), revg . 33 T .C . 572 (1959 ) and Morris Plan Co . v . Commissioner, 33 T .C . 720 (1960)) ; se e also . Robinson, -- supra , at 9 ;-(°"Nonrecourse loans created by contrac t can -take whatever :' formmeets 'the' needs of-the parties") And w e note that- .'even''if the' . taxpayer" does not pay interest during th e loan term, upon satisfaction of the, debt"the full amount of 'th e Tufts , 4 61~ U .S .-at, -;308-.09 :, , Crane - 331 U S ' v :: at 12-13= and section 1 .1001-2,(a), Income T'ax (cid:127)Regs .- Accord' Allan v . Commissioner ; 86 part of th e T .C . 655, 666-67 '(1986), affd .856 F .2d 1169 (8th Cir . 1988) . .There for,e,'ythe taxpayer pays taxes o .n . .d_fscharged inter=est,,so it 66 - Finally, the majority notes that the parties did' .not .-treat gas ,a ;loan because the exact loan amount was not ' fixed .unti l afte r Derivium determined the proceeds it would receive from : This factor should not impute knowledgek .t o -Calloway that Derivium was selling the stock, however., because it was consistent with the terms of the agreement . Schedule .A-l, , Property Description and Loan Terms, stated that the total loa n amount. . would be "90% of the market value on closing" .a,ndMclosing was,to take place "upon receipt of securities and establishment- of * . * * [Derivium's] hedging transactions ." This isno different from a home equity line of credit whose preciselimit depends on an appraisal and subsequent loan-to-value calculat .ion'. VI . . Even. if . we didn't want to accept Calloway' s deal ash a-_loan- omits face, we should at least use a more sensible=multifacto r test-here . -Taking the factors from Welch and the old BTA=cases ' would yield a different result : Existence of Promissory Note .' While there is no ;promissory . note, the "Master Agreement to Provide Financing and, Custodia l ,Services" .bears the markings of a loan agreement . The;,;recitals ' 'Welch v . Commissioner , 204 F .3d 1228, 1230 (9th Cir . 2000 ) (existence of debt instrument), affg . v . Commissioner , 30 B .T .A . 433, 440 (1934) (contents of debt instrument) . T .C . Memo . 1998=121Fishe r 67 - in . .the contract,- :use -loan , languages , 'speci'fying. : "This Agreemen t is made * t'o prov;id e or arrange :f inancing (s) and to provid e custodial service s ;[petiti:oner ] ., with 'respect'..-to certai n properties, : and ; assets be~'T;pledged . as security . The . services .promised ; in Section- 1, include (cid:127)" [p]roviding' or arranging . financing by ._ way of . one or, more lo ans ",and "[h]'olding l cash, . securities, or=other, -liquidh assiet.s * *. as collateral,",-action s ;indicating initial-. treatment, ,as ;a- .loan . Section 9 binds th e parties and, their-,assigns .',i Schedule A-1 . lists . theinterest rate , maturity_ date,. ., a d other terms°x of'iathew loan . ,T This documen t therefore . acts : at least=formally as a- debt : instrument . Observing Formalities, .of¢Loan .8' ..:The,.parties' ; continuin g course . of deal-ing also ., supp.orts . a 'finding that they intended' to create a ioan',because .they followed-° through with the loa . Derivium, .senlt-,Ca1-lowayx,,quarterly account statement s n formalities .showing the ; : amount of, interest accrued, _,the loan, .,-balance, .. the " maturity-,date,, : and- they. pro_j ected balance at maturity . Those , statements show that Derivium actually-did add interest to th e loan,balance(cid:127) ., The quarter :Ly.. statements and the end-of-quarter loan balance ; reflect interest - accruing at th e'", :agreed -'rate .' Derivium ; even sent Calloway .-a '"notice that the 4~loan term was ' 8 See United' :Natl . Co± .p ." v . Commissioner, 33 B .T .A . 790, 794 (1..935) . :rending,°and inquired as to what Calloway intended,to'do . responded that he intended to surrender his collateral : 68 - cInterest Payments or Loan Repayment .9 It's certainly . true " that'Derivium' s loans were structured to provide for a'bal'loon . payment .°., :But we have seen loans without interim interest : payments before . At one time, lenders tried to getaway fro m paying income tax on interest income by giving "original- -issue . discounts" instead of charging interest . Lenders would extenda a supposedly interest-free $95 loan, for example, but then require : the borrower to :repay $100 at the end of the term . ' See' Traveler s Ins . Co v . United States , 25 Cl . Ct . 141, 143 (1992 ) caught on and enacted section 1281(a), which imputes interest: .income to'holders of original-issue-discount securities , demonstrating that interest can accrue without actual payment : dur ng .the loan term and without turning the loan into(cid:127)=a sal e See,'also~ United States v . Midland-Ross Corp . , 381 U .S 54 , 66(1965) . A loan isn't even required to bear any interes t all if the .parties agree . Welch , 204 F .3d at 1230 (citation s omitted) . The Commissioner may have a stronger point if terms of ..,.thepurported loan called for interest payment s Calloway. didn't pay . But nonpayment of interest according towthe terms of the agreement is unpersuasive . 9Welch , 204 F. .3d at 1230-31 . .Duty : to Repay- .yar d Commissioner ; says' Deri.vium'"s transactions weren't loans becaus e the customers had the right to walk away . But'Calloway didn' t have the right to :walk' away- ':scot ..,free-=he had t .o sur-render hi s discussed above , .the duty'to'repay and reasonabl e loan . See. supra . .pt .'. IV .-A . ~.' Nonrecourse 'loans ' have satisfie d these . tests if, atthe beginning's ofa the ''loan, it makes economi c sens e 'for :the .borrower"t Sufficient Funds- to ;: Make -Loan,.,11 Our cases also tell -u s that if -a"lender'doesn't have sufficient funds to make the loa n at hand, .then the t ransaction 'is-more ' like a sale Welch,-20 4 scam got going, ' Deriviumrv had ,sufficient funds on hand until the . whole thing collapsed . The record is'''clear that Derivium sen t Calloway fund's'-before, it 'received" they proceeds from the' IB M stock, so the -'loan-I could not" have been "funded by the sale . -- Se e majority op . ': p . 9'- ("On August 2l-'-- ;2,00l, Derivium sent, t o petitioner aletter ' 'info'rming him that ' the proceeds of the loa n were sent to him On that same date, a $93,586 .23 wir e transfer was received and credited to petitioner's account * * 10Id United Nati . , 33 B .T .A . at 79 .6 . 1'We ch., 204 F :3d'wat ' -1230 * ") ; majority op . p . 8 ("On August 22, 2001, the ne t from , the sale of the IBM stock settled into Deriviumf s 70 - Keegan . account .") . Ratio of Price Paid to Property Value .12 Without ;.other- evidence, ; if ,a lender lends full price for the purported- , collateral . it looks like a sale . United Natl . Corp . , 33 B ..T .A . at .797. . But ... at what discount should the court infe r parties intended a loan? In Fisher , the Board of Tax,Appeals' . noted that ;a purchase for substantially less than-fair--market" " value may .allow the Court to rescind a sale from an oppressiv e "lender",,,,but a small discount coupled with the right to t repurchase "does not signify that a loan was intended .''. ; B .T .A .at 441 . The discount in that case was not enough t o .recharacterize the purported sale as a loan . This is admittedl y a,-closerquest-ion, but when one of Derivium's customers :didn' receive full price for his shares and doesn't ask us to .change- the formal characterization of the transaction, I think thi s factoris consistent with intent to take out a loan, or~at,leas t -insufficient to recharacterize the loan as a sale . 12United Natl . , 33 B .T .A . at 797 ; Fisher , 30 B .T .A>..-at 44 .1 . Derivium' s Intent and Conduct . " 7 1 the various tests . in the-, casellaw requir e .conduct of both .cparties But "intent" .,:is notexact :ly th e word what-we-think we should b e parties . to a :deal is :,trying to, prom ses,of a secret,hedgng_strategyand its continual flow o f false statements to tits customers, , suggest to any . reasonabl e -observer'i hindsight, that., its intent' was- ..not to make eithe r loan'or a sale , but a quick theft of 10 percent of the . stock' s value .- taut L)erivium, s a .C other litigation .show .. a desir e t o least publicly- represent their transactions as loans . ., E ..g,,r Derivium Capital LLC v .--United States Trustee, 97 AFTR2 d 2006-2582 (S . ..D .N,.Y . 2006)~,(stating that-California court grante d summary judgment motion declaring-transactions were loans that Derivium ; .intended,to file-~bankruptcy motion . to ge t determination -that transactions were-loans, not sales) . no doubt ..that . the facts of this . case , are ugly . relied on a promoter in'entering the transaction , testified the transaction was tax motivated, and didn't repor t consistently with his own characterization of the transaction b y 13Welch - ;204, F .-2d _ at ; 1230 ; United Natl : , '33 B .T .A . at, 794 ; .Fisher , x 30 B .T .A-. at 440 ; see .-also Grodt .77 T .C . 12211: 1237 ' :.(19.81)- .,. Commissioner , &= McKay Realty:; Inc . 'v . - 72 - failing to recognize dividends paid on the co.llate.rth L during the .loan term and the disposition of the stock as'a sale fore the' amount of the accrued debt at the close of the mloani~ .A':1 These .°facts ., while supporting the result in this case, may differ significantly from cases where Derivium's customers .were_dupes rather than, at least to some degree, in on the con . Never mind,, says=,the majority, in both classes of case, the initial transfe r of stock from a customer's account to Derivium's is asale tax :.purposes . 1 4 :But-to return to where I began, this case and all th e °Derivium cases should be easy . If there was a bona fide . nonrecourse loan, followed by the sale of collateral , .. the tax rules are : clear . According to section 1 .1001-2(a)(4) Income Tax Regs .., "the sale * * * of property that secures .=a nonrecours e liability . discharges the transferor from the liability ." And . when a nonrecourse liability is discharged by sale of collateral , the borrower must recognize income at that point--the amoun t realized 'is .the amount of nonrecourse liability discharged as a , "These worries are somewhat alleviated by the majority' s appropriately narrow application of the penalties . In finding, for the Commissioner on that issue, the majority relies exclusively on Calloway's personal treatment of the transactio n reliance on a promoter, and his failure to prove reasonabl e reliance on other professionals . the'.. sale.'5=k 'Tufts , .461-U,. S . at 308 - 09 Crane , 331 U .S . 1986 -141 (treatin g stamp collection=as sold : -b'y 'taxpayer .1 in "year pawnbroaker sold i t aS.-0 pposed to :year taxpayer' received 'money from pawnbroker ) . first transaction then,,wdul-d°not be a recognition event fo r Calloway'. but 'Deriv um' s sale-=even its' secret sale= would .16 event s flowing 'from,-t-he 'result reached- by the majority .17 15The -timing of the recognition event would be .the same i f the loan were' a recourse loan, but there are some differences in . tax treatment, when a recour .se, loan is, satisfied by . ;the- sale o f collateral for less than the debt amount . t In that case the stoc k owner. would recognize gain or . 1oss of the sale . price less his basis, plus cancellation-of-debt income in the amount of the .deb t forg ven .;;less the sale .p.rice .H See Gehl v . Commissioner , 10 .2,T C . 784, 789-90 (1994), affd . without published opinion 50 F .3d 12 (8th Ci'r . 1995) ;, sec . 1=. 1001-2,(a)-,,,,In-come, Tax Regs . ; ., Rev . Rul- . 90-16, 1990-1 C .B . 12 . The-cancellation-of-debt income woul d potentiallyA be ; subj ect-.. .to- an, insolvency exclusion . See sec . 108 (a ) (1) (B) . noted above,,while . a,secured ,,party~holds securities, as betwee n .the two the debtor is conside red the owner . of the securities . U . C . sec- . a 9-20 .7 cmt< .. 6 -( Example ) ..- But .if . then securedy partysells the underlying securities "by virtue of the debtor's consent or applicable legal rules" .then "the debtor normally would retain no interest in the securit[ies] following th e purchase [by a third party]-from the 'secured party .", . Id- sec . 9-314 cmt . 3 . 17Because 'of a-'small amount of ' accrued interest, time the loan was made. until the stock' was sold,'-Calloway woul d actually- have a 'slightly higher deficiency if we - found hi s transaction-:-to be 'a bona fide loan . The Commissioner hasn't mad e '(continued : : .) 'from the' - 74 - There are, finally, some potentially odd consequence-s,o'f , this- ;opinion . Consider first an easy variation--a simple, „ collateralized loan subject to the same standard contract , language .-as in Derivium's forms . The stock stays in the lender', s electronic equivalent of a desk drawer, the borrower-repays ,,th e loan and regains control of the stock . Does this becom e on the, initial transfer? And a repurchase when the loan -,,repaid ? Or consider the example of subordination loans--stock s transferred by an owner to a broker or dealer . The : transfero r keep's his voting rights and dividends, but gives the transfere e the'" right to 'sell the transferred stock and retain the'a proceeds . (This sort of deal is beneficial to the transferor°because'he' gets .'a .stream of payments equal to a percentage of the value , the'securities he's transferred . And it's beneficial .to the broker or dealer because such securities count - toward'his"' min'imu m net-capital requirements .) Courts have always called these loans . "rathe'r'than sales, despite the right of the transferee S"ee, ' e . g° , Cruttenden v . Commissioner , 644 F . 2d 1368, 1374-7 5 17( . . . continued ) any claim for this little bit of extra deficiency, so-he wouldn' t get it ., See Baker v . Commissioner , T .C . Memo . 2008-247-(citin g Estate_of_.Petschek v . Commissioner , 81 T .C . 260, 271;-72 ,(1983,),' affd .P738=F .2d 67 (2d Cir . 1984), and Koufman v . Commissioner ,;69 ;. T -Q ., _473, 475-76 (1977)) (9th Cir . 1981), affg . 70 T .C . 191 (1978) ; Lorch v . Commissioner , 605 F .2d 657, 660 (2.d Cir . 1979), affg . 70 T .C . 674 (1978 ) Or, perhaps especially, consider the increasingly comple x financial instruments like re;pos_andcustomized derivatives . All . of these alter'the "benefits and burdens" of ownership, but some that take on the form of sales are treated as loans . Kleinbard , supra at 798 & n .79 ("For tax purposes, repos traditionally hav e been treated as secured loans of money ." (citing Rev . Rul . 79- 108, 1979-1 C .B . 75, Rev . Rul . 77-59, 1977-1 C .B . 196, and Rev . Rul . 74-27, 1974-1 C .B . 24)) : ; see also Neb . Dept . of Revenue v . Loewenstein , 513 U .S . 123, 130-31 (1994) (finding repos are loan s for . purposes of 31 U .S .C . section 3124(a)) . Must all now be subject to the uncertainty of the Grodt & McKay test ? I respectfully concur in the result in this case and eve n the imposition of penalties (because Calloway did not respect hi s own characterization of the transaction as a loan) . But unles s future courts .treat,our analysis today as a limited-time ticke t good only on Derivium cases, we may be creating more problem s than we're solving .