Opinion
Docket No. 51666.
1956-08-30
ALBERT KURTIN AND PATRICIA BRISTOL KURTIN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Bernard Weiss, Esq., for the petitioners. A. Jesse Duke, Jr., Esq., for the respondent.
Bernard Weiss, Esq., for the petitioners. A. Jesse Duke, Jr., Esq., for the respondent.
Losses on sales of butter futures entered into to protect taxpayers against decline in the price of cheese purchased under forward contracts at a fixed price, held, on the facts, to be allowable in full as hedging transactions.
Respondent determined a deficiency of $3,127.56 in petitioners' income tax for the calendar year 1950. The issue presented is whether net losses, realized in 1948 by the partnership of which Albert Kurtin was a member, from transactions in butter futures resulted from hedging transactions and are hence allowable as part of a net operating loss carryover to petitioners' 1950 income.
FINDINGS OF FACT.
Some of the facts have been stipulated and are hereby found.
Albert Kurtin, hereafter called petitioner, filed his Federal income tax return for the calendar year 1946 with the collector of internal revenue for the second district of New York, and for the calendar years 1947, 1948, and 1950 with the collector of internal revenue for the third district of New York. He incurred net losses in 1946 and 1947 and no taxes were paid for those years.
Petitioner was, in 1947 and 1948, a member of the partnership of Albert Kurtin & Co., organized in July 1947, with principal place of business in New York. The partnership was composed of petitioner, with a 90 per cent interest in profits and losses, and Ida Kurtin, his mother, with a 10 per cent interest in profits and losses. The partnership books and records were maintained on an accrual basis and its returns were filed on an accrual and calendar year basis with the collector of internal revenue for the second district of New York. Its first return covered the taxable period July 1 to December 31, 1947. Its return for 1948 disclosed a net loss of $79,203.14, of which amount petitioner reported $70,912.83 as his distributive share and Ida Kurtin, $8,290.31. Included in this net loss was a net loss of $52,404.40 on transactions in commodity futures, made up as follows:
+----------------------------------+ ¦Commodity ¦Profit ¦Loss ¦ +--------------+--------+----------¦ ¦Hides ¦$240 ¦ ¦ +--------------+--------+----------¦ ¦Corn ¦ ¦$1,425.00 ¦ +--------------+--------+----------¦ ¦Cocoa ¦ ¦22.00 ¦ +--------------+--------+----------¦ ¦Cottonseed Oil¦ ¦6,984.00 ¦ +--------------+--------+----------¦ ¦Cotton ¦ ¦22,417.50 ¦ +--------------+--------+----------¦ ¦Lard ¦2,310 ¦ ¦ +--------------+--------+----------¦ ¦Wheat ¦1,415 ¦ ¦ +--------------+--------+----------¦ ¦Eggs ¦656 ¦ ¦ +--------------+--------+----------¦ ¦Butter ¦ ¦26,176.90 ¦ +--------------+--------+----------¦ ¦Total ¦$4,621 ¦$57,025.40¦ +----------------------------------+
In computing the net operating loss deduction for 1950, resulting from the carry-forward of the loss from 1948, respondent has disallowed as an operating expense all of the net losses sustained on transactions in commodity futures. Petitioner contests such action only with respect to transactions in butter futures resulting in a net loss of $26,176.90.
The partnership was duly registered as futures commission merchants, pursuant to the Commodity Exchange Act, and held certificates for 1947 and 1948 issued by the United States Department of Agriculture. Petitioner was a registered floor broker under the Commodity Exchange Act for 1947 and 1948 with the United States Department of Agriculture. On August 4, 1947, the partnership became members of the New York Mercantile Exchange, and on November 6, 1947, petitioner purchased a membership on the Chicago Mercantile Exchange. In June 1948 petitioner sold his membership in the Chicago Mercantile Exchange and in July 1948 petitioner and the partnership withdrew from membership with the New York Mercantile Exchange.
The partnership, during 1947 and 1948, was engaged in the business of receiving and wholesaling cheese and eggs and one or two other commodities. It also acted as commissioned brokers, representing outside interests, in the purchases and sales of commodity futures contracts on the New York Mercantile Exchange. During 1948 it did not engage in the business of receiving or wholesaling butter. Orally and through representatives it entered into arrangements to purchase the entire season's output of cheese from cooperative factories throughout the Middle West. At the time these arrangements were entered into, neither quality, quantity, nor price of the cheese to be purchased and delivered was known. These facts would be known about 2 or 3 months after the arrangements had been made and after the cheese had been made, aged, and graded. The price was determined by a formula based upon the average price of butter during the month that milk was delivered by the farmers to the cheese manufacturers. This interrelation of price is attributable to the fact that butterfat is the principal ingredient common to butter, cheese, and milk. Because butter, of these three items, is the largest volume item with a quotable market, the prices of the other two are governed largely by and tend to fluctuate with the average price of butter. Situations could arise whereby factors other than the cost of the raw material could affect the price of either butter or cheese without affecting immediately the price of the other.
The partnership sold its cheese to jobbers who then sold it to consumer outlets. Cheese was not generally sold by the partnership prior to receipt because it was subject to purchasers' grading and inspecting. To protect against a decline in cheese prices for the period of time between the arrangements with and the actual shipment by the cheese manufacturer, petitioner sold butter futures short. As the cheese was sold petitioner would close out his short position in butter futures. The trade practice in 1947 and 1948, generally, was to sell butter short against cheese commitments. During 1948 the selling price of cheese declined causing a loss to the partnership. Meanwhile the butter market was sustained by unusual circumstances and petitioner suffered the loss on the short sales in controversy. The partnership went out of business in 1948.
The butter futures contracts in question were hedging transactions and a part of the partnership business, rather than speculative transactions in capital assets.
OPINION.
OPPER, Judge:
That the butter futures contracts closed out by petitioner at a loss were hedges within the meaning of G.C.M. 17322
and the cases applying it seems to us inescapable both as a factual and as a legal conclusion. The commitment as to which petitioner sought to insure himself against loss was his purchase of certain types of cheese for future delivery. His agreements with the procedures required him several months later to accept the product at the previously stipulated price.
XV— 2 C.B. 151 (1936).
The uncontradicted testimony was that there is no futures market for cheese but that the price of cheese, being dependent on butterfat, normally fluctuates with that of butter as to which the sale of futures is available. Under ordinary circumstances petitioner could hence look forward to recovering on closing out the futures transactions at least a part of the loss occasioned by any decline in cheese prices between the date of commitment and the time of delivery. This was as appropriate a hedge as was available to petitioner.
It is true that petitioner's agreement with the cheese producers were not formal written contracts. But he testified without contradiction that they were binding upon the parties and were so treated. It is also true that due to unusual circumstances the price of cheese declined and that of butter rose. The result to petitioner was that the insurance he sought did not materialize. But we think that circumstance along with the other facts no more deprives this arrangement of its qualities as an attempted hedging operation than would the fortuitous ineffectiveness of an insurance policy prevent premiums paid from being treated as expended for insurance purposes.
We have been referred to no case where on similar facts the benefit of deduction as a loss on a hedging transaction was denied. The cases relied on by respondent are clearly distinguishable. Thus in Trenton Cotton Oil Co. v. Commissioner, (C.A. 6) 147 F.2d 33, for example, the court says:
The real question here is whether petitioner's contracts for the purchase of refined oil futures were made to protect it against loss on the purchases of cottonseed or on the sale of crude oil for future delivery.
The Tax Court found as a fact that petitioner's purchases were not for that purpose. This finding is supported by substantial evidence.
Here on the contrary we have found as a fact from ample evidence that petitioner sold the butter futures to protect himself against loss on the sale of the cheese, to the purchase of which at a fixed price he was already committed.
In Corn Products Refining Co. v. Commissioner, 350 U.S. 46, affirming on this point (C.A. 2) 215 F.2d 513, which in turn affirmed a Memorandum Opinion of the Tax Court, the taxpayer which was in the business of manufacturing products out of raw corn, ‘At harvest time each year * * * would buy (corn) futures when the price appeared favorable. * * * If shortages appeared * * * it sold futures only as it bought spot corn for grinding. In this manner it reached a balanced position with reference to any increase in spot corn prices. It made no effort to protect itself against a decline in prices.’ The Court concludes: ‘it appears that the transactions were vitally important to the company's business as a form of insurance against increases in the price of raw corn. * * * ’
As respondent correctly states:
This Court has said that whether futures activities in a particular case were for speculation or for hedging is ‘largely a factual question.’ * * * Hedging transactions in commodities ‘may take several different forms depending upon the particular circumstances in which the hedger finds himself and the type of risk which he seeks to avoid.’ * * *
In discussing the Corn Products case respondent in effect maintains that petitioner cannot succeed unless it is ‘shown that petitioner's transactions in butter futures were entered into to provide price risk insurance through hedging.'
Our interpretation of the present facts is that petitioner has been shown to have done just that and we have so found. On the principle of the Corn Products case and on the present record pertitioner's sale of butter futures was undertaken in an effort to protect himself against a decline in cheese prices which would normally be accompanied by a decline in butter prices. As in Corn Products Refining Co. v. Commissioner, supra, we conclude that this was an integral part of petitioner's business operations and should be allowed as an ordinary business item and not merely as a capital loss. Fulton Bag & Cotton Mills, 22 T.C. 1044; Stewart Silk Corporation, 9 T.C. 174.
He further says: ‘The very definition of hedging itself and, in fact, the only manner in which futures transactions could constitute a hedge and assure any degree of price risk insurance in the instant case, contemplates an opposite position in futures market from that held in actual and the closing out of such positions simultaneously so that loss on the one side will be offset by gain on the other.’
Decision will be entered under Rule 50.