Judges: HAINES
Attorneys: William A. Roberts and Kyle R. Coleman , for petitioners. Christopher S. Kippes , for respondent.
Filed: Apr. 13, 2011
Latest Update: Dec. 05, 2020
Summary: T.C. Memo. 2011-85 UNITED STATES TAX COURT RICARDO A. AND TARI SCURLOCK GARCIA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 19813-06. Filed April 13, 2011. William A. Roberts and Kyle R. Coleman, for petitioners. Christopher S. Kippes, Daniel L. Timmons, and Jeffrey L. Dorfman, for respondent. MEMORANDUM OPINION HAINES, Judge: This case is before the Court on respondent’s motion for partial summary judgment filed pursuant to Rule 121.1 1 Unless otherwise indicated, all
Summary: T.C. Memo. 2011-85 UNITED STATES TAX COURT RICARDO A. AND TARI SCURLOCK GARCIA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 19813-06. Filed April 13, 2011. William A. Roberts and Kyle R. Coleman, for petitioners. Christopher S. Kippes, Daniel L. Timmons, and Jeffrey L. Dorfman, for respondent. MEMORANDUM OPINION HAINES, Judge: This case is before the Court on respondent’s motion for partial summary judgment filed pursuant to Rule 121.1 1 Unless otherwise indicated, all ..
More
T.C. Memo. 2011-85
UNITED STATES TAX COURT
RICARDO A. AND TARI SCURLOCK GARCIA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19813-06. Filed April 13, 2011.
William A. Roberts and Kyle R. Coleman, for petitioners.
Christopher S. Kippes, Daniel L. Timmons, and Jeffrey L.
Dorfman, for respondent.
MEMORANDUM OPINION
HAINES, Judge: This case is before the Court on
respondent’s motion for partial summary judgment filed pursuant
to Rule 121.1
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
- 2 -
We must decide whether over-the-counter foreign currency
options entered into by a limited liability company wholly owned
by petitioner Ricardo A. Garcia were “foreign currency contracts”
under section 1256.
The following facts are based upon the parties’ pleadings,
affidavits, stipulations, and exhibits in support of and in
opposition to the motion for partial summary judgment. They are
stated solely for the purpose of deciding the motion and not as
findings of fact. See Fed. R. Civ. P. 52(a).
Background
At the time of the filing of the petition, petitioners
resided in Texas.
At all times relevant to this case, petitioner Ricardo A.
Garcia owned 100 percent of the membership units of 0464, L.L.C.,
a Georgia limited liability company (the LLC). The LLC was
treated as a disregarded entity for Federal income tax purposes.
On December 4 and 5, 2002, the LLC sold eight foreign
currency options to Montgomery Global Advisors V LLC, based in
San Francisco, California (Montgomery), for $21,419,177. The LLC
also purchased eight offsetting foreign currency options from
Montgomery for $21,449,177. The net premium paid by the LLC was
$30,000. The maturity date for each option was December 27,
2002. Eight of the foreign currency options had barrier
- 3 -
features.2 None of the options were securities traded on a
qualified board or exchange as defined by section 1256(g)(7).
The options pegged to the European euro (euro) and the U.S.
dollar are major foreign currency options, and the options pegged
to the Danish krone are minor foreign currency options.3 The
following chart summarizes the foreign currency option positions
held by the LLC on December 5, 2002, the long positions having
been purchased from Montgomery by the LLC and the short positions
having been sold by the LLC to Montgomery:
2
“Barrier” options are a type of option whose exercise is
dependent on the option’s reaching, or failing to reach, a
certain price. There are two types of barrier options, “knock-
in” and “knock-out” options. “Knock-in” options are not
exercisable unless the barrier price is reached before the
expiration of the option. “Knock-out” options, on the other
hand, are exercisable only if the barrier price is not reached
before the expiration of the option. The barrier feature does
not change the fact that the derivative is an option. Therefore,
a barrier feature does not change our analysis hereunder.
3
A major foreign currency is a “currency in which positions
are * * * traded through regulated futures contracts”. Sec.
1256(g)(2)(A)(i). The term “regulated futures contract”, as
defined in sec. 1256(g)(1), means “a contract--(A) with respect
to which the amount required to be deposited and the amount which
may be withdrawn depends on a system of marking to market, and
(B) which is traded on or subject to the rules of a qualified
board or exchange.” Major currencies include the U.S. dollar,
British pound, Japanese yen, Swiss franc, and the euro. Minor
currencies include the Danish krone.
- 4 -
Foreign Currency Option Positions 1-16
Position Strike Price Base Currency Counter Currency Premium
1 Long EUR/USD 1.0006 USD/EUR €525,000,000 $525,315,000 ($5,055,763)
2 Short EUR/USD 1.0006 USD/EUR €525,000,000 $525,315,000 3,759,337
3 Long EUR/USD 1.0005 USD/EUR €525,000,000 $525,262,500 (144)
4 Short EUR/USD 1.0005 USD/EUR €525,000,000 $525,262,500 1,281,570
5 Long DKK/USD 7.4211 DKK/USD Kr 3,898,404,210 $525,315,000 (5,398,005)
6 Short DKK/USD 7.4211 DKK/USD Kr 3,898,404,210 $525,315,000 5,398,005
7 Long EUR/DKK 7.4255 DKK/EUR €525,000,000 Kr 3,898,404,210 (231,350)
8 Short EUR/DKK 7.4255 DKK/EUR €525,000,000 Kr 3,898,404,210 231,350
9 Long EUR/USD 0.9999 USD/EUR €525,000,000 $524,947,500 (5,170,322)
10 Short EUR/USD 0.9999 USD/EUR €525,000,000 $524,947,500 4,096,924
11 Long EUR/USD 1.0000 USD/EUR €525,000,000 $525,000,000 (72)
12 Short EUR/USD 1.0000 USD/EUR €525,000,000 $525,000,000 1,058,470
13 Long DKK/USD 7.4255 DKK/USD Kr 3,897,997,661 $524,947,500 (5,383,430)
14 Short DKK/USD 7.4255 DKK/USD Kr 3,897,997,661 $524,947,500 5,383,430
15 Long EUR/DKK 7.4248 DKK/EUR €525,000,000 Kr 3,897,997,661 (210,091)
16 Short EUR/DKK 7.4248 DKK/EUR €525,000,000 Kr 3,897,997,661 210,091
- 5 -
On December 20, 2002, the LLC assigned approximately 0.81
percent of long position 5, 50.20 percent of short position 6,
58.78 percent of long position 9, 49.30 percent of long position
13, and 56.17 percent of short position 14 to the Holy Innocents
Building Fund (the Building Fund), an organization claiming
section 170(c)(2) charitable status. The Building Fund assumed
obligations with respect to the two short positions totaling
$5,691,561 and received three long positions valued in the
aggregate at $5,694,561, providing for a net value of the
positions assigned to the Building Fund of $3,000.
When the LLC assigned 58.78 percent of the long position 9
to the Building Fund, it was valued at $39,192 and the LLC’s
claimed adjusted basis in the position was $3,039,192. On their
2002 Federal income tax return, petitioners took the position
that because long position 9 was a major foreign currency option,
the assignment was subject to the mark-to-market rules under
section 1256 and Greene v. United States,
79 F.3d 1348 (2d Cir.
1996).4 Accordingly, because petitioner Ricardo A. Garcia was
4
Petitioners received a tax opinion dated Dec. 31, 2002,
from Garza & Staples, P.C., which concluded that: (1) Major
foreign currency options are subject to the mark-to-market rules
of sec. 1256; (2) the assignment of a major foreign currency
option to a charity triggers a termination under sec. 1256 and
Greene v. United States,
79 F.3d 1348 (2d Cir. 1996); and (3)
petitioners must recognize gains and losses with respect to any
major foreign currency option assigned to a charity. Unlike the
present case, however, Greene dealt with transfers of regulated
futures contracts to a charity. Regulated futures contracts are
sec. 1256 contracts. Sec. 1256(b)(1), (g)(1).
- 6 -
the sole member of the LLC, petitioners reported a loss of $3
million with respect to the portion of the long position 9
assigned to the Building Fund. On the other hand, because long
positions 5, 6, 13, and 14 were minor foreign currency options
denominated in the Danish krone, petitioners took the position
that they were not subject to the mark-to-market rules under
section 1256 and did not report any gain or loss from those
positions on their 2002 Federal income tax return.
Petitioners filed a timely Federal income tax return for
2002. A notice of deficiency was mailed to petitioners on
September 6, 2006, and petitioners timely filed their petition
with this Court.
Discussion
Summary judgment is intended to expedite litigation and
avoid unnecessary and expensive trials. Fla. Peach Corp. v.
Commissioner,
90 T.C. 678, 681 (1988). The Court may grant
summary judgment when there is no genuine issue of material fact
and a decision may be rendered as matter of law. Rule 121(b);
Sundstrand Corp. v. Commissioner,
98 T.C. 518, 520 (1992), affd.
17 F.3d 965 (7th Cir. 1994); Zaentz v. Commissioner,
90 T.C. 753,
754 (1988). The Court will view any factual material and
inferences in the light most favorable to the nonmoving party.
Dahlstrom v. Commissioner,
85 T.C. 812, 821 (1985); Naftel v.
Commissioner,
85 T.C. 527, 529 (1985). We conclude that there
- 7 -
are no genuine issues of material fact on the section 1256 issue
and a decision may be rendered as a matter of law. Respondent’s
motion will be granted, denying the purported loss on the
assignment of the major foreign currency option to the Building
Fund.
I. Section 1256
Section 1256(a)(1) generally permits certain financial
instruments to be marked to market on the last business day of
the taxable year and any gain or loss on those contracts to be
included on the taxpayer’s Federal income tax return. Any gain
or loss with respect to a “section 1256 contract” is treated as a
short-term capital gain or loss to the extent of 40 percent of
such gain or loss and a long-term capital gain or loss to the
extent of 60 percent of such gain or loss. Sec. 1256(a)(3). The
taxpayer may argue that a loss is characterized as ordinary if
the transaction also qualifies as a section 988 transaction.5
Section 1256(b) defines a “section 1256 contract” to
include: (1) Any regulated futures contract; (2) any foreign
currency contract; (3) any nonequity option; (4) any dealer
equity option; and (5) any dealer securities futures contract.
Section 1256(b) excludes from the definition of a “section 1256
contract” any securities futures contract or option on such a
5
See sec. 988(a)(1)(A) and sec. 1.988-3(a), Income Tax
Regs., which override the characterization of capital losses
specified in sec. 1256 if sec. 988 also applies.
- 8 -
contract unless the contract or option is a dealer securities
futures contract.6
A “regulated futures contract” means a contract with respect
to which the amount required to be deposited and the amount which
may be withdrawn depend on a system of marking to market and
which is traded on or subject to the rules of a qualified board
or exchange. Sec. 1256(g)(1). A qualified exchange means a
national securities exchange which is registered with the
Securities and Exchange Commission, a domestic board of trade
designated as a contract market by the Commodity Futures Trading
Commission, or any other exchange, board of trade, or other
market which the Secretary determines has rules adequate to carry
out the purposes of section 1256. Sec. 1256(g)(7).
In contrast, section 1256(g)(2) covers contracts that are
not traded on a qualified exchange; i.e., foreign currency
contracts. A “foreign currency contract” is defined as a
contract:
(i) which requires delivery of, or the settlement of
which depends on the value of, a foreign currency which is a
currency in which positions are also traded through
regulated future contracts,
(ii) which is traded in the interbank market, and
6
In 2010 sec. 1256(b) was amended pursuant to the Dodd-Frank
Wall Street Reform and Consumer Protection Act, Pub. L. 111-203,
sec. 1601, 124 Stat. 2223 (2010), to additionally exclude from
the definition of a “section 1256 contract” any interest rate
swap, currency swap, basis swap, interest rate cap, interest rate
floor, commodity swap, equity swap, equity index swap, credit
default swap, or similar agreement.
- 9 -
(iii) which is entered into at arm’s length at a price
determined by reference to the price in the interbank
market. [Id.]
For a more detailed discussion on the language, requirements, and
legislative history of section 1256, see this Court’s recent
decision in Summitt v. Commissioner,
134 T.C. 248 (2010).
II. Major/Minor Transactions
The issue before us arises in the context of what are
sometimes known as “major/minor” transactions. Major/minor
transactions typically involve a taxpayer’s engaging in
offsetting “long” and “short” major and minor foreign currency
options. The “long” and “short” positions in each option move
inversely in value with respect to each other. Accordingly, at
any particular time the options provide the holder substantially
offsetting gain and loss positions.
A major/minor transaction usually involves a taxpayer’s
assigning a major foreign currency long option that has a
potential loss to a charity.7 Again, relying on section
1256(g)(2) and Greene v. United States,
79 F.3d 1348 (2d Cir.
1996), the taxpayer takes the position for Federal tax purposes
that the major foreign currency long option assigned to the
charity is a section 1256 “foreign currency contract” and marks
7
A charity is an organization defined in sec. 170(c)(2)
contributions to which are deductible for income tax purposes as
charitable contributions.
- 10 -
to market the major foreign currency long option when the option
is assigned, recognizing a loss at that time.
In contrast, because the taxpayer takes the position that
the assigned minor foreign currency option is not a section 1256
“foreign currency contract”, the taxpayer claims that the
charity’s assumption of the minor obligation does not cause the
taxpayer to recognize gain. Further, the taxpayer does not
recognize gain when the option either expires or terminates.
III. Summitt
We must decide whether a major foreign currency option comes
within the meaning of “foreign currency contract” so as to
qualify for section 1256 treatment. This is the same issue we
decided in Summitt v.
Commissioner, supra. In Summitt, we held
that it does not. We see no reason to decide this case
differently.
The taxpayers in Summitt were shareholders of an S
corporation. The corporation purchased two major foreign
currency options and sold two minor foreign currency options.
The major foreign currency options were reciprocal put and call
positions pegged to the U.S. dollar and the euro.8 Similarly,
8
In Summitt v. Commissioner,
134 T.C. 248 (2010), we
referred to reciprocal “put” and “call” options and, therefore,
use the same terms here in our discussion of Summitt. In brief
and throughout the record, the parties used the terms “short” and
“long” to refer to the subject foreign currency options.
Accordingly, we refer to the subject foreign currency options as
“short” and “long” options in our discussion of the facts and
(continued...)
- 11 -
the minor foreign currency options were reciprocal put and call
positions; however, those positions were pegged to the U.S.
dollar and the Danish krone. The net premium paid by the
corporation in respect of the two major and the two minor options
was $17,500.
Soon after purchasing the two major and the two minor
options, the corporation assigned the major call option and the
minor call option to a charity. At the time of the assignment,
the corporation held a loss position in the major call option and
a substantially offsetting gain position in the minor call
option. Pursuant to section 1256, the corporation reported the
loss on the major call position, and not the gain on its minor
call position, on its Federal income tax return.
In Summitt v.
Commissioner, supra at 264, we analyzed the
“delivery” or “settlement” requirement under section 1256(g)(2),
concluding:
A foreign currency option is a unilateral contract that does
not require delivery or settlement unless and until the
option is exercised by the holder. An obligation to settle
may never arise if the holder does not exercise its rights
under the option. It is clear that, as originally enacted
in 1982, * * * [the statute] applied only to forward
contracts. The statute referred to a contract which
required delivery of the foreign currency, not to a contract
in which delivery was left to the discretion of the holder.
8
(...continued)
analysis of this case. Despite the difference in terminology,
the “short” and “long” foreign currency options in this case have
the same characteristics as the “put” and “call” foreign currency
options discussed in Summitt, respectively. We have not
considered whether those terms are interchangeable in any other
circumstances.
- 12 -
We further held that the phrase “or the settlement of which
depends on the value of” in section 1256(g)(2)(A)(i), which was
added to the original statute pursuant to the Deficit Reduction
Act of 1984, Pub. L. 98-369, sec. 722(a)(2), 98 Stat. 972, was
added:
to allow a cash-settled forward contract to come within the
term “foreign currency contract”. Foreign currency
contracts can be physically settled or cash-settled, but
they still must require, by their terms at inception,
settlement at expiration. * * * [Id. at 264-265.]
Finding the plain language of the statute to be “dispositive”, we
held that a foreign currency option does not fall within the
meaning of a “foreign currency contract” under section
1256(g)(2).
Id. at 265.
The only factual distinction the Court sees between the
options discussed in Summitt v.
Commissioner, supra, and the
options before us is the fact that the options in this case had
barrier features. As stated above, a barrier feature does not
change the fact that the derivative is an option. Accordingly,
consistent with our conclusion in Summitt, we find that the
foreign currency options petitioners entered into are not
“foreign currency contracts” as defined by section 1256(g)(2),
and we sustain respondent’s determinations for 2002 with respect
to respondent’s motion for partial summary judgement.
Petitioners argue that Summitt was decided on an incomplete
factual base. Petitioners suggest that because Summitt was
- 13 -
decided without the testimony of a foreign currency options
expert, the Court did not have the information needed to make a
proper judgment. We disagree. Summitt v. Commissioner,
134 T.C.
248 (2010), like this case, was decided on summary judgment and,
therefore, the facts were viewed in a light most favorable to the
taxpayers. Under those circumstances Summitt held that foreign
currency options were economically distinguishable from contracts
covered by section 1256.
Id. at 263-266. The testimony
suggested by petitioners is nothing more than the legal
conclusions of a supposed industry expert. We made our legal
determination on the section 1256 issue in Summitt.
We have considered all of petitioner’s contentions,
arguments, and requests that are not discussed herein, and we
conclude that they are without merit or irrelevant.
To reflect the foregoing,
An appropriate order will
be issued.