On Appeal from the United States Tax Court; T.C. Nos. 79-10239, 80-22295, 81-23614.
Sloviter, Chief Judge, and Greenberg and Higginbotham, Circuit Judges.
This case involves the continuing saga of a crackdown by the Commissioner of Internal Revenue on a tax shelter device we will call the "option-straddle transaction" and the divers attempts of various taxpayers to avoid the consequences of this crackdown.
The particular straddle transactions involved silver options on the London Metals Exchange. Appellant-taxpayers, Charles S. Lerman, Joseph L. Faites, and Dwight B. Massey, who on this appeal are assumed to be commodities dealers, engaged in the transactions on the Exchange, and deducted losses, for 1975, 1976, and 1977 purportedly incurred in those transactions. The Commissioner disallowed the deductions and assessed deficiencies against them. The appellants sought a redetermination of the deficiencies in the Tax Court, and both sides moved for summary judgment.
The Tax Court granted the Commissioner's motion, holding that the transactions were devoid of economic substance and therefore created no "loss" for which a deduction could be based. Fox v. Comm'r, 56 T.C.M. (CCH) 863 (1988). The Tax Court rejected the appellants' argument that, because they were commodities dealers, section 108(b) of the Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 108(b), 98 Stat. 494, 630, as amended by the Tax Reform Act of 1986, Pub. L. No. 99-514, § 1808(d)(2), (4), 100 Stat. 2085, 2817-18, reprinted at I.R.C. (26 U.S.C.) § 1092 note (1988) (hereinafter "section 108(b)"), countenanced the deductions. Section 108 (a) provides that "any loss" "form[ing] part of a [pre-1982] straddle" "shall be allowed" "if such loss is incurred in a trade or business" or "if such loss is incurred in a transaction entered into for profit though not connected with a trade or business." I.R.C. § 1092 note (section 108(a)). Section 108 (b) provides an irrebuttable presumption that any straddle-related " loss incurred by a commodities dealer in the trading of commodities shall be treated as a loss incurred in a trade or business." Id. (section 108(b)) (emphasis added). The Tax Court held that the irrebuttable trade-or-business-loss presumption of section 108(b) is inapplicable to sham transactions devoid of economic substance, and thus cannot justify the deductions.
We agree. If a transaction is devoid of economic substance -- as the transactions involved here undeniably were --, it simply is not recognized for federal taxation purposes, for better or for worse. This denial of recognition means that a sham transaction, devoid of economic substance, cannot be the basis for a deductible "loss." Section 108, then, which allows deductions for losses incurred pursuant to straddle transactions, is inapplicable to straddle transactions devoid of economic substance as there is no "loss" to which the presumption provided by section 108 can apply.
The Tax Court had jurisdiction pursuant to I.R.C. §§ 6214(a), 7442. We have jurisdiction to review final decisions of the Tax Court pursuant to 28 U.S.C. § 1291, and I.R.C. § 7482(a). Inasmuch as the appellants resided in New Jersey at the time of the filing of their respective petitions to the Tax Court, venue for these appeals lies in this court pursuant to I.R.C. § 7482(b)(1)(A). Timely notices of appeal were respectively filed by the taxpayers and the Commissioner.*fn1
The underlying facts of this case are essentially not in dispute. Each appellant claims to be a "commodities dealer" as that term is used in the Code,*fn2 and each seeks to deduct losses incurred as a result of dealings in option-straddle transactions engaged in through brokers operating on the London Metal Exchange in 1975, 1976 and 1977.*fn3 In a prior, unrelated case, Glass v. Comm'r, 87 T.C. 1087 (1986), which we discuss in further detail infra, the Tax Court held that the London option-straddle transactions are shams, lacking in economic substance. The petitioners in Glass were therefore denied the deductions they claimed as "losses" incurred from the transactions. 87 T.C. at 1177. Significantly, however, the Glass court stated that, "the case before us does not involve commodities dealers." Id. at 1167.
The parties here stipulated that the "London options transactions at issue in this case are of the same type as those described by the Court in Glass et al. v. Commissioner, 87 T.C. 1087, 87 T.C. No. 68 (Nov. 17, 1986) in the Court's Findings of Fact, Section III A." They thus agree, per Glass, that the transactions in this case were shams, lacking economic substance. Appellants nonetheless moved before the Tax Court for summary judgment, arguing that as commodities dealers they should be permitted to deduct the losses pursuant to section 108(b). Appellants contended that, because they are commodities dealers, under section 108(b) they are presumed to have incurred the straddle-generated losses in a trade or business, and that the transactions in which they engaged therefore cannot be classified as shams devoid of economic substance. They argued that their case was distinguishable from Glass, which did not involve commodities dealers. The Commissioner, however, refused to concede that appellants were dealers and the Tax Court held that "we are unable to establish from the stipulated facts that petitioners were 'persons who [were] actively engaged in trading [I.R.C. § ] 1256 contracts and [were] registered with a domestic board of trade which is designated as a contract market by the Commodities Futures Trading Commission' during the years at issue." 56 T.C.M. at 866. See n.2 ante. Since the appellants' commodities dealer status remained in dispute, and since their entitlement to the presumption provided by section 108 revolved around this controverted issue of material fact, the Tax Court denied their summary judgment motion, a disposition not before us on appeal. 56 T.C.M. at 867.
The Commissioner cross-moved for summary judgment on the basis that, as a matter of law, even if the appellants were commodities dealers they were not entitled to the deductions. Relying on its opinion in Glass for the proposition that the London option-straddle transactions were devoid of economic substance, and on its opinion in Cook v. Comm'r, 90 T.C. 975 (1988), aff'd, 931 F.2d 59 (9th Cir. 1991) (table), holding that since the London option-straddle transactions are economic shams devoid of substance even commodities dealers may not take deductions based on losses sustained in the transactions, the Tax Court granted the Commissioner's motion. The court held that, as a matter of law, even if appellants are commodities dealers, the London option-straddle transactions are shams, 56 T.C.M. at 869, and that since the transactions therefore lack economic substance, they produce no "loss" to which section 108 could apply. Id.
The Tax Court based its summary judgment on a legal determination regarding the construction of section 108 and thus our review is plenary. See Pleasant Summit Land Corp. v. Comm'r, 863 F.2d 263, 268 (3d Cir. 1988), cert. denied, 493 U.S. 901, 107 L. Ed. 2d 210, 110 S. Ct. 260 (1989); Casper v. Comm'r, 805 F.2d 902, 904 (10th Cir. 1986) (Tax Court's decision to grant summary judgment is legal determination reviewable de novo by court of appeals). As the Commissioner was the prevailing party in the Tax Court, we resolve all controverted issues of material fact in favor of the appellants and accordingly, like the Tax Court, for the purposes of this appeal we assume that they are commodities dealers.
The London Option-Straddle Transactions*fn4
The London Metal Exchange is a commodity exchange on which cash, futures, and option contracts in silver, copper, zinc, tin, and lead are traded. Unlike its counterparts in the United States, such as the Chicago Board Options Exchange, the Exchange does not operate as a clearing house for trades. Rather, all transactions on or subject to Exchange rules are executed on a principal-to-principal basis, meaning that a person purchasing an option or futures contract through a broker/dealer, purchases that contract from the broker/dealer. The broker/dealer does not operate simply as an agent for a third party.
A person can trade on the Exchange in options or futures or both. The three most common forms of options are call, put, and double options. A call option gives the holder/buyer the right to buy from the grantor/seller a specified quantity of a commodity at an agreed price at any time before the option's expiration date. A put option gives the holder the right to sell a specified quantity of a commodity at an agreed price to the grantor at any time before the option's expiration date. A double option gives the holder the right either to sell or buy the underlying commodity at the agreed price before the option's expiration date. Under an option contract the holder has the right but not the obligation to purchase or sell the stated commodity at the agreed price and, accordingly, is never at risk for more than the cost of the option.
A futures contract requires the buyer to receive, and the seller to deliver, a specified quantity of a given commodity at some future date. Although a futures contract is legally binding between the parties, actual delivery of the underlying commodity rarely occurs. In traded futures and traded options, the contract is normally terminated ("closed out") before actual delivery by offsets, that is, the ...