Opinion
Docket No. 54920.
1956-04-30
FRANK C. LAGRANGE AND EILEEN M. LAGRANGE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Benjamin Mahler, Esq., for the petitioners. Nathan M. Silverstein, Esq., for the respondent.
Benjamin Mahler, Esq., for the petitioners. Nathan M. Silverstein, Esq., for the respondent.
On July 28 and August 24, 1949, petitioner Frank C. LaGrange entered into two short sales of English pounds sterling for delivery on February 28 and March 31, 1950. Immediately prior to the delivery dates, petitioner sold the short sales contracts to his brokerage firm. The amount paid by the brokerage firm was a sum equal to the difference between the proceeds of the short sale and the cost of pounds sterling to cover the short sale. The brokerage firm made no profit from the transactions and could have sustained no loss because it required petitioner to remain fully liable for any loss thereon until delivery of pounds sterling to the purchasers was completed, just as he would have been had he personally made the covering purchases of pounds sterling and thus consummated the short sales. Held, the purchase of petitioner's contracts by his brokerage firm was not a bona fide transaction, and the gain therefrom is, therefore, a short-term capital gain since the holding period of the pounds sterling with which the short sales were consummated was less than 6 months. Regs. 111, sec. 29.117-6.
This proceeding involves a deficiency in income tax for the year 1950 in the amount of $12,281.29.
The issue is whether gains from two short sales of English pounds sterling should be taxed as short-term or as long-term capital gains.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
Frank C. LaGrange (hereinafter referred to as petitioner) and his wife, Eileen M. LaGrange, were residents of Forest Hills, New York, during the year in issue, and filed their joint Federal income tax return for such year with the former collector of internal revenue for the second district of New York.
During the year in issue, petitioner was a member of the New York Stock Exchange, the Chicago Board of Trade, and other commodity exchanges. He conducted a brokerage business under the name of LaGrange & Company, with offices at New York City, New York.
In January 1949, petitioner arranged with the brokerage firm of Carl M. Loeb, Rhoades & Co. (hereinafter referred to as Loeb, Rhoades), for clearing of LaGrange & Company's stock transactions. Petitioner also traded individually through Loeb, Rhoades in securities, commodities, and foreign exchange.
On or about July 28, 1949, petitioner directed Loeb, Rhoades to sell 30,000 English pounds sterling at the then prevailing rate of exchange, for delivery on February 28, 1950. Loeb, Rhoades effected such sale, through a foreign exchange broker, to a French bank, Societe Generale. The French bank confirmed such sale by a memorandum to Loeb, Rhoades on July 28, 1949, indicating that they had bought 30,000 English pounds sterling for delivery on February 28, 1950, by cable transfer on London, at the rate of $3.76 1/8 per pound. For handling this transaction, Loeb, Rhoades charged petitioner a commission of $113 and entered such charge onto its ledger sheet kept for petitioner's business. Such commission was a so-called round-trip commission, which meant that when the covering purchase was subsequently made and petitioner's short position thus closed out, no further commission would be charged by Loeb, Rhoades.
On August 24, 1949, petitioner directed Loeb, Rhoades to sell 15,000 English pounds sterling, at the then prevailing rate of exchange, for delivery on March 31, 1950. On that date Loeb, Rhoades effected such sale to Brown Brothers Harriman & Co., who confirmed such purchase by a memorandum dated August 24, 1949, sent to Loeb, Rhoades, indicating that they had bought such pounds sterling for delivery in March, by cable transfer on London, at $3.72 3/8 per pound. Loeb, Rhoades handled the sale to Brown Brothers Harriman & Co., through the same broker who had handled the previous sale to the French bank. Loeb, Rhoades charged petitioner a round-trip commission of $56 on such sale. On August 24, 1949, it addressed the following letter to petitioner:
CARL M. LOEB, RHOADES & CO.
61 Broadway, New York 6, N.Y.
August 24, 1949
COPY
Mr. FRANK C. LAGRANGE
61 BROADWAY, ROOM 2518
NEW YORK 6, N.Y.
DEAR SIR:
In connection with the Foreign Exchange contracts which we are carrying for your account on our books, in order that there may be no misunderstanding we write to advise you that all these and any additional contracts which we may enter into on your behalf, including the one that is being confirmed to you today, are entirely for your account and risk, as the confirmation itself sets forth. In other words, all these orders have been executed through regular Foreign Exchange brokers and the specific contracts booked to your account. All the risks of the specific contracts are yours and we particularly want to call your attention to the fact that if, as and when, for any reason, the contracts are not or cannot be fulfilled due to inability or unwillingness of the counterparties to do so, or because some existing or future regulation of a governmental or other authority intervenes, the liability and risk are entirely and solely yours.
Kindly signify your understanding of the foregoing by signing and returning to us the copy of this letter.
Very truly yours,
HAW:AH
(Signed) FRANK C. LAGRANGE
On September 18, 1949, the English pound sterling was devalued so that the rate of exchange was approximately.$2.80 per pound. Petitioner had entered into the above-described short sales in the belief that the English pound sterling would be devalued and, after its devaluation, he knew that he would make a substantial profit on such short sales.
On or about February 24, 1950, petitioner advised Loeb, Rhoades that he desired to sell the contract of July 28, 1949, and, after discussion with officials of Loeb, Rhoades, that firm agreed to buy such contract. On that date, it purchased 30,000 English pounds sterling from the Chemical Bank for delivery in London on February 28, at.$2.80 1/8, the then rate of exchange. It made an entry on its books to the effect that such purchase of pounds sterling had been made to close out the contracts which it had purchased from the petitioner. Also on February 24, 1950, Loeb, Rhoades addressed the following letter to petitioner:
CARL M. LOEB, RHOADES & CO.
61 Broadway
New York
NEW YORK 6, February 24, 1950
Mr. FRANK C. LAGRANGE
61 BROADWAY, ROOM 2518
NEW YORK 6, N.Y.
DEAR SIR:
We hereby confirm having bought from you the following foreign exchange forward contract originally sold by us as your agent for your account and risk: 30,000 pounds sold on July 28, 1949 at 3.76 maturing February 28, 1950, as per confirmation sent you under date of July 28, 1949
This purchase is made with the understanding that if the above mentioned contract is not liquidated properly in accordance with its original terms for any reason whatsoever you shall be fully liable to us.
Please signify your assent by signing the enclosed copy of this letter.
Very truly yours,
(Signed) CARL M. LOEB
MD:al.
By hand
(Signed) FRANK C. LAGRANGE
Loeb, Rhoades also, on that date, delivered the following statement to petitioner:
Pursuant to our attached letter, dated February 24, 1950, we bought from you for settlement February 28th, 1950 the 30,000 pounds Foreign Exchange Forward Sale Contract mentioned therein for a consideration of $28,760.20, arrived at in accordance with the computation attached hereto:
+-----------------------------+ ¦Sale Contract: ¦ ¦ +-----------------+-----------¦ ¦£ 30,000 at 3.76 ¦$112,800.00¦ +-----------------------------+
Purchase effected by us in cover of the above Sale Contract: £ 30,000 at 2.80 1/8 84,037.50 $28,762.50 Less: Cable charge 2.30 Net consideration due you $28,760.20
We shall credit your account with the above consideration money on February 28th, 1950.
On February 28, 1950, Loeb, Rhoades credited petitioner's account in the amount of $28,760.20, and mailed the following statement to him:
+-----------------------------------------------------------------------------+ ¦Description ¦Debit ¦Credit ¦ +-----------------------------------------------------------+-------+---------¦ ¦Consideration Money due you covering our Purchase from you ¦ ¦ ¦ ¦on February 24, 1950 for value February 28, 1950, of ¦ ¦ ¦ ¦Foreign Exchange Forward Sale Contract for £>>30,000., ¦ ¦ ¦ ¦pursuant to our letter and separate computation statement ¦ ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦dated February 24th ¦28,760.20¦ +-----------------------------------------------------------------------------+
On or about March 28, 1950, petitioner advised Loeb, Rhoades that he wished to sell his contract of August 24, 1949, to deliver 15,000 English pounds sterling. After discussion with officials of the firm, Loeb, Rhoades again agreed to purchase the contract from petitioner and, on that date, it purchased 15,000 pounds sterling from the Chemical Bank at.$2.80 1/8 per pound, for delivery in London on March 31. Loeb, Rhoades made an entry on its books reflecting such covering purchase to close out the contract which it had purchased from petitioner. On that date, it sent a letter to petitioner, similar to the one sent to him on February 24, 1950, to the effect that the purchase of his contract was made with the understanding that it would be closed out completely at his risk. Also, on March 28, it mailed a statement to petitioner which read as follows:
Pursuant to our attached letter, dated March 28th, 1950, we bought from you for settlement March 31st, 1950, the L15,000. Foreign Exchange Forward Sale Contract mentioned therein for a consideration of $13,816.45, arrived at in accordance with the computation attached hereto:
+--------------------------------+ ¦Sale contract: ¦ ¦ +---------------------+----------¦ ¦£ 15,000. at 3.72 1/4¦$55,837.50¦ +--------------------------------+
Purchase effected by us in cover of the above Sale Contract: £ 15,000. at 2.80 1/8 42,018.75 $13,818.75 Less: Cable charge 2.30 Net consideration due you $13,816.45
We shall credit your account with the above consideration money on March 31st, 1950.
On March 31, it credited his account with $13,816.45, and mailed the following statement to him:
+-----------------------------------------------------------------------------+ ¦Description ¦Debit ¦Credit ¦ +-----------------------------------------------------------+-------+---------¦ ¦Consideration Money due you covering our Purchase from you ¦ ¦ ¦ ¦on March 28, 1950, for value March 31, 1950 of Foreign ¦ ¦ ¦ ¦Exchange Forward Sale Contract for £>>15,000., pursuant to ¦ ¦13,816.45¦ ¦our letter and separate computation statement dated March ¦ ¦ ¦ ¦28th ¦ ¦ ¦ +-----------------------------------------------------------------------------+
Loeb, Rhoades made no profit on the purchase of the contracts from petitioner, except the round-trip commissions charged by it when the short sales were originally made in July and August 1949.
On the joint return which petitioners filed for 1950, they reported long-term gains of $42,576.65 on the foregoing foreign exchange transactions. In his deficiency notice, respondent determined that such gains should have been reported as short-term capital gains.
Petitioner closed out the short sales of English pounds sterling, made by him in July and August 1949, by covering purchases in February and March 1950; and, since such covering purchases were held less than 6 months, the gain is a short-term capital gain.
OPINION
RICE, Judge:
Section 117(g)(1)
provides that gains or losses from short sales of property shall be considered as gains or losses from the sales or exchanges of capital assets. Treasury Regulations 111, section 29.117-6,
SEC. 117. CAPITAL GAINS AND LOSSES.(g) GAINS AND LOSSES FROM SHORT SALES, ETC.— For the purpose of this chapter—(1) gains or losses from short sales of property shall be considered as gains or losses from sales or exchanges of capital assets; * * *
provide that, for income tax purposes, a short sale is not deemed to be consummated until delivery of property to cover such short sale has been made, and that the holding period, for purposes of determining whether the gain thereon is taxable as a long- or short-term gain, shall be the time the property delivered to cover such short sale was held.
Regulations 111.SEC. 29.117-6. GAINS AND LOSSES FROM SHORT SALES.— For income tax purposes, a short sale is not deemed to be consummated until delivery of property to cover the short sale, and the percentage of the recognized gain or loss to be taken into account under section 117(b) from a short sale shall be computed according to the period for which the property so delivered was held. Thus, if a taxpayer made a short sale of shares of stock and covered the short sale by purchasing and delivering shares which he held for not more than six months, 100 percent of the recognized gain or loss would be taken into account under section 117(b), even though he had on hand other shares of the same stock which he held for more than six months. If the short sale is made through a broker and the broker borrows property to make delivery, the short sale is not deemed to be consummated until the obligation of the seller created by the short sale is finally discharged by delivery of property to the broker to replace the property borrowed by the broker.
Petitioner does not question the validity of the foregoing regulation, but argues that it is inapplicable here, because he did not complete the short sales which he entered into in July and August 1949. He argues that when he made such short sales he acquired specific contract rights which, in and of themselves, constituted capital assets; and, that rather than fulfill his obligation by making delivery on the short sales, he sold his contract rights, which he had held for more than 6 months prior to their sale.
The respondent, on the other hand, argues that the petitioner did not sell any contracts to Loeb, Rhoades in February and March 1950, but, for all practical purposes, covered the short sales by having Loeb, Rhoades purchase English pounds sterling from the Chemical Bank on February 24 and March 28, 1950; that those pounds were delivered in London by cable transfer on the delivery dates specified in the short sales contracts— February 28 and March 31, 1950; and that, therefore, the holding period on the delivery dates specified in the short sales contracts— February 28 and March 31, 1950; and that, therefore, the holding period of the property so delivered was less than 6 months, and that the gains which petitioner realized were, therefore, short-term capital gains.
Testimony at the hearing indicated that petitioner told the representatives of Loeb, Rhoades at the time the contracts were supposedly purchased by it from him that he desired to realize long-term capital gains on the profits arising from the short sales. Petitioner, of course, had every right to conduct his transactions in foreign exchange in any legitimate manner by which he could realize the maximum tax benefit, and for that he is not to be penalized. Commissioner v. Tower, 327 U.S. 280 (1946); Gregory v. Helvering, 293 U.S. 465 (1935); and Jack Benny, 25 T.C. 197 (1955), appeal dismissed (C.A. 9). But, we agree with the respondent here that the so-called purchase of short sales contracts by Loeb, Rhoades was nothing more than a cloak to disguise covering purchase transactions by petitioner, and that such contract purchases by Loeb, Rhoades, therefore, were not realistic purchases for income tax purposes. Except for the book entries which Loeb, Rhoades made to the effect that it had purchased petitioner's short sales contracts and a similar reference in the letters written to him on February 24 and March 28, 1950, the short sales were closed out in exactly the same manner as if petitioner, himself, had directed Loeb, Rhoades, as his brokerage agent, to purchase English pounds sterling to cover the contracts. We think that is what, in fact, happened.
The significant fact, which persuades us that the contract purchase transactions were not what petitioner contends, is that petitioner remained fully liable as the short seller until the sales were finally consummated and closed out by delivery of English pounds sterling to the purchasers. That liability is clearly evidenced by the letters which Loeb, Rhoades wrote to petitioner on February 24 and March 28, 1950. Loeb, Rhoades made no profit on the purchase of petitioner's contracts, and it likewise could not have sustained one penny of loss because the risk remained petitioner's until the sales were consummated. A representative of Loeb, Rhoades testified that it was willing to purchase petitioner's contracts at no profit to itself because petitioner's firm was a large customer and Loeb, Rhoades would thereby incur goodwill by so accommodating him. Be that as it may, no explanation was offered to show why petitioner was required to carry the full and complete risk on the transactions, just as he would have done had Loeb, Rhoades acted only as his agent rather than as the alleged ‘purchaser’ of his contracts. We, therefore, conclude, on the record before us, that the so-called purchase of contracts was merely an attempt to disguise the normal consummation of the short sales into which petitioner entered in 1949, and that the holding period of the pounds sterling with which such sales were closed out was less than the 6-month period required by the statute. Petitioner's gains on the transactions were, therefore, short-term capital gains.
Decision will be entered for the respondent.