Opinion ID: 613690
Heading Depth: 4
Heading Rank: 2

Heading: Whether Taxpayers Reported the Transaction Correctly

Text: Taxpayers' second argument is that § 1058 is largely irrelevant and, that their tax treatment of the transaction was correct even if the transaction is not viewed as a securities loan at all. Rather than the purchase and immediate resale of the Securities, creating short-term capital gain, Taxpayers argue that what really happened in 2003 was that they liquidated a contractual right to receive the Securities from Refco (the Contractual Right). The Contractual Right was a capital asset that they acquired in consideration of their 2001 sale of the Securities to Refco; their basis in it was the price that first Taxpayers and then Refco paid for the Securities in 2001 ($1.643 billion). Over a year later, in 2003, that asset was liquidated when Refco paid Taxpayers the market value of the Securities in lieu of delivering the actual Securities. The liquidation of the capital asset yielded exactly the long-term capital gain that Taxpayers reported, not the short-term capital gain that the Commissioner argues they should have reported. Taxpayers are correct that a contractual right of this nature could be a capital asset under § 1221 and that gain attributable to the cancellation or termination of such an asset is capital gain under § 1234A, which provides that [g]ain or loss attributable to the cancellation, lapse, expiration, or other termination of . . . a right or obligation . . . with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer . . . shall be treated as gain or loss from the sale of a capital asset. § 1234A. See also Wolff v. Comm'r, 148 F.3d 186, 188 (2d Cir.1998) ([A] gain or loss from the cancellation of a futures or forward contract would result in capital gain or loss pursuant to [§ 1234A].). The Commissioner in turn argues that Taxpayers' theory is valid only if the Contractual Right was cancelled or terminated, rather than merely fulfilled, in 2003. In other words, if Refco actually did sell the Securities to Taxpayers as the Contractual Right obligated them to do, there was no cancellation or termination of the capital asset, and the Tax Court's interpretation of the 2003 events as yielding short-term capital gain is correct. The Commissioner has the better argument on this point. The Commissioner is correct that there is nothing in the record to support the assertion that Refco cancelled or terminated its contract with Taxpayers. The Loan Agreement required Refco to return the Securities to Taxpayers, and there is no evidence in the record of any discussion between them that would constitute an acknowledgment that this obligation would not be met. The parties also stipulated in the Tax Court that Shiloh sold the Securities to Refco at that time, which Shiloh could not have done if Refco had not first delivered the Securities to Shiloh as Refco was required to do under the Contractual Right. It is true that the Commissioner's pointing to Taxpayers' and Refco's characterization of the events in 2003 is a bit disingenuous, because the Commissioner's argument and the Tax Court's position is that the labels the parties themselves put on the transaction should be disregarded. But that does not mean that Taxpayers therefore must have the right to call the transaction whatever they want after the fact. It is also true that the 2003 exchange was settled via offset, with Taxpayers neither taking title to the Securities nor transferring any funds to Refco. But given Taxpayers' and Refco's characterization of the transaction as a securities loan and the fact that Taxpayers never actually held the cash collateral in their account, it would have been impossible for the 2003 exchange to be structured otherwise. For example, a transfer of title to Taxpayers in 2003 would have made no sense, because the parties assumed that Taxpayers were already the owner of the Securities. In addition, Taxpayers' argument implies that the tax treatment of a transaction like this one should be determined by the relatively trivial matter of whether the purported securities lender received securities or cash equal to the market value of the securities at the end of the loan term. If we were to agree with Taxpayers' argument, then parties to similar transactions could obtain tax treatment equivalent to that which they would have obtained under § 1058, despite not complying with either the letter or the spirit of that provision, merely by making sure that the broker gives the lender cash instead of securities at the end of the term. (The lender could then use that cash to purchase the same securities, if he wished to hold them for a longer period.)