*1205 Petitioner was engaged in the business of operating an independent cottonseed oil mill. Such operation consisted in buying and processing cottonseed and selling the products derived therefrom, namely, crude cottonseed oil, cottonseed meal, cotton linters, cottonseed hulls, cotton oil fibers, and bran. Crude cottonseed oil must be sold within a few weeks after production to avoid loss in value from deterioration in quality. Beyond such period it can not be withheld from sale to await an advantageous market. Because of such market hazard it is the general practice of the operators of such mills to buy futures contracts for refined cottonseed oil (a nonperishable commodity) when crude is sold on a market deemed unsatisfactory. Petitioner followed this practice in the taxable year. It took no delivery of refined oil under its futures contracts and at no time had any refined oil stocks in its inventory. Its transactions in respect of refined oil consisted wholly in buying and selling such futures contracts without any intention of demanding or receiving delivery thereunder. In such transactions petitioner sustained a loss in the taxable year in excess of $24,000 and deducted the*1206 amount thereof from gross income in its income tax return for such year. Respondent held that the loss resulted from sales of capital assets and disallowed so much thereof as exceeds $2,000 plus capital gains, and on the basis of such disallowance determined a deficiency in income tax. Held, that the futures contracts were capital assets and that the loss resulting from sales thereof is deductible only to the extent allowed by respondent. Sec. 117, Revenue Act of 1934.
*255 This is a proceeding to review respondent's determination of an income tax deficiency of $3,019.05 for the fiscal year ended June 30, 1936. The question is whether petitioner's losses from transactions in commodity "futures" are deductible in full from its gross income or only to the extent allowable for capital losses under section 117 of the Revenue Act of 1934.
FINDINGS OF FACT.
The petitioner is an Alabama corporation, with its principal offices in the city of Birmingham, Alabama. It operates an independent cottonseed*1207 oil mill. Such a mill is one that has no facilities for refining cottonseed oil or is not owned or operated by a person having *256 such facilities. It is engaged in the business of processing cottonseed purchased from local gins during the ginning seasons and selling the products derived therefrom, namely, crude cottonseed oil, cottonseed meal, cotton linters, cotton hulls, cotton oil fibers, and bran. Of these derivatives of raw cottonseed the product known as "crude cottonseed oil" is salable only to refineries where it is subjected to further processing to convert it into the merchantable product known as "refined cottonseed oil." Refined cottonseed oil is a food commodity of long keeping qualities and has a recognized market standing throughout the year in produce exchanges. In contrast to these characteristics of refined cottonseed oil, crude cottonseed oil is not a food product. It is highly perishable and deteriorates rapidly, especially in the summer months. Petitioner's business is seasonal, lasting usually from late in August to April or May following, when cotton gins are in operation. Because of the perishability of crude oil the business requires practically*1208 a current monthly disposal of it as it comes from the mill. Accordingly, petitioner provided storage capacity for only about a month's mill run of crude oil. A larger storage capacity would entail expenditures without corresponding advantages. When the storage tanks are full petitioner must either sell its crude oil or cease operations and suffer consequent deterioration both of its crude oil and its raw materials, for both are perishable commodities. Hence, petitioner's business required the continuous operation of its plant during the season above indicated and timely sales of its crude oil regardless of the hazard of unfavorable markets. Because of such hazard of its business the petitioner has followed a plan for several years, including the taxable year, of sometimes buying futures in refined oil on a produce exchange through brokers, when sales of crude were made upon an unsatisfactory market. This plan was adopted and followed by all such independent operators. There is no futures market for crude oil. There is a direct, if not fixed, relationship between the market price of refined oil and of crude oil as of a given date of delivery. The market price of the former*1209 is determined in large part by the market price of the latter plus freight to the refinery, the cost of refining, the loss in refining, and such other expense, if any, as is incident to the operation of converting crude into refined oil. The purchases of refined oil futures were made following sales of crude but not always on the same date and not always in the converted equivalent amounts of the crude sold. The customary practice followed was first to sell the crude oil at the prevailing market price and then place orders with brokers to purchase futures on a produce exchange at prices named by the petitioner. If petitioner's orders could not be filled readily at the price designated *257 by it, the orders were carried until purchases could be had at such prices. Such purchases were sometimes made weeks later than the corresponding sales of crude.
The petitioner's mill operations in the taxable year began in August or early September 1935, and continued into 1936. Before October 1, 1935, the petitioner manufactured and sold 1,080,000 pounds of crude oil at prices satisfactory to it. As to such sales no corresponding purchases of refined oil futures were made. Thereafter*1210 it made other sales of crude oil at prices not satisfactory to it, and made corresponding purchases of refined futures. We set out below a schedule showing dates, purchasers, and amounts of oil (by pounds) involved in these latter sales; and immediately following that is a schedule showing transactions in "futures" which were made, as petitioner claims, to match such sales, including data showing petitioner's losses in liquidations of the latter.
| Sales of Crude Oil | |||
| Date | To Whom Sold | Shipment | Pounds |
| 1935 | |||
| 10-16 | Southern Cotton Oil Co | Quick | 180,000 |
| 10-16 | Wilson & Co., Inc | do | 420,000 |
| 10-18 | do | Prompt | 60,000 |
| 10-22 | do | do | 300,000 |
| 10-22 | do | do | 180,000 |
| 10-25 | do | do | 60,000 |
| 10-28 | do | do | 180,000 |
| 10-30 | Proctor & Gamble | do | 360,000 |
| 11-20 | Durkee Famous Foods | Immediate | 300,000 |
| 12-6 | Lever Bros. Co | do | 180,000 |
| 12-6 | do | do | 120,000 |
| 1936 | |||
| 1-8 | Wilson & Co., Inc | 600,000 | |
| Total | 2,940,000 |
Transactions in refined oil futures:
| Date acquired | Date sold | Quantity purchased pounds | Cost |
| 11-22-35 | 4-13-36 | 180000 | $19,314.00 |
| 11-22-35 | 4-13-36 | 120000 | 12,876.00 |
| 11-26-35 | 4-13-36 | 180000 | 19,170.00 |
| 11-26-35 | 4-13-36 | 120000 | 12,768.00 |
| 1-9-36 | 4-13-36 | 300000 | 29,610.00 |
| 1-9-36 | 4-13-36 | 180000 | 17,838.00 |
| 1-9-36 | 4-13-36 | 120000 | 11,904.00 |
| 1-9-36 | 4-13-36 | 120000 | 11,928.00 |
| 1-9-36 | 4-13-36 | 180000 | 17,910.00 |
| 2-7-36 | 4-13-36 | 60000 | 5,970.00 |
| 2- 7-36 | 4-13-36 | 300000 | 29,850.00 |
| 12-12-35 | 4-13-36 | 120000 | 12,744.00 |
| 12-12-35 | 4-13-36 | 60000 | 6,372.00 |
| 12-17-35 | 4-18-36 | 120000 | 12,600.00 |
| 2-17-35 | 4-21-36 | 60000 | 6,300.00 |
| 12-19-35 | 4-21-36 | 60000 | 6,300.00 |
| 12-20-35 | 4-21-36 | 120000 | 12,600.00 |
| 12-28-35 | 4-21-36 | 60000 | 6,300.00 |
| 1- 9-36 | 6-25-36 | 300000 | 29,700.00 |
| Totals | 2760000 | 282,054.00 |
*1211 *259 Crude oil loses about 9 percent by processing it into refined oil. In the taxable year petitioner sold 2,940,000 pounds of crude oil at prices unsatisfactory to it and made purchases of 2,760,000 pounds of refined oil futures. 2,760,000 pounds of refined oil is the approximate equivalent in pounds of 3,033,000 pounds of crude oil. The quantity unit both in the transactions in crude and refined oil is a tank of 60,000 pounds. During the taxable year the market price of crude oil averaged approximately nine cents a pound or $5,400 per tank. Refined oil futures were bought on margin at about $300 per tank. Petitioner could have demanded delivery of refined oil under its futures contracts but it made no such demand and the contracts were entered into with the intention not to demand or receive such delivery. Its transactions in this respect consisted entirely of purchases and sales of contracts for future delivery of refined oil. If the market at the delivery date under a futures contract was not satisfactory the contract was at times transferred to a further future date. Ultimately the contract was sold and assignment thereof made to the vendee, and the profit or*1212 loss on the transaction realized. Contracts for refined oil futures required no investment for storage, transportation or insurance. Accordingly, about $300 per tank plus brokerage commissions constituted petitioner's investment in the futures contracts and its oil stocks were not affected by the purchase or sale of such contracts. Transactions in such futures contracts were entered into by petitioner solely as a protective measure against sales of crude oil, which it was compelled to make at prices deemed unsatisfactory, by enabling it to maintain a position in respect of future market conditions of refined oil which it was powerless to maintain in respect of crude oil. Such futures contracts were bought and sold only on the Produce Exchange through brokers, and petitioner had no customers of its own in respect thereof. They were not stock in trade. They were not property held by petitioner primarily for sale to customers in the ordinary course of its trade or business.
In the taxable year petitioner sustained a loss in its transactions in refined oil futures of $24,024.
In its income tax return for the taxable year petitioner deducted from gross income the amount of such*1213 loss. Respondent contends that the loss in question resulted from the sale of capital assets and disallowed as a deduction so much thereof as exceeds $2,000 plus capital gains, and determined the deficiency herein on that basis.
OPINION.
HILL: The petitioner contends that the losses it sustained in its dealings in refined oil futures were normal business losses. This *260 claim is based primarily upon the broad hypothesis that the initial processing of raw cottonseed is so related to the manufacture of refined cottonseed oil as to make stocks of the latter product invoiceable as regular "stock in trade" of the processor. Secondarily, the petitioner contends that, in any event, its dealings in oil futures were transactions entered into for profit and that the resulting losses are deductible under section 23(f) of the Revenue Act of 1934 as having been sustained during the taxable year and not compensated for by "insurance or otherwise."
The respondent concedes petitioner's loss but contends that its investments in refined oil futures were capital assets within the definition set out in paragraph (b) of section 117, Revenue Act of 1934, as follows:
(b) DEFINITION*1214 OF CAPITAL ASSETS. - For the purposes of this title, "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.
If the respondent is correct in his classification of these assets, his holding must be sustained since the law limits deductions for losses from sales or exchanges of capital assets to $2,000, plus gains from such transactions. Sec. 117(d), Revenue Act 1934; Joseph R. Seeds,37 B.T.A. 705">37 B.T.A. 705. In this proceeding the burden is upon petitioner to show that respondent's classification is incorrect. Lightsey v. Commissioner, 63 Fed.(2d) 254.
The definition quoted identifies as "capital assets" property held by a taxpayer "whether or not connected with his trade or business", except stock in trade, property includable in the inventory of the taxpayer if on hand at the close of the taxable*1215 year, or property held "primarily for sale to customers in the ordinary course of his trade or business." The petitioner claims that the assets here involved were held under these excepted categories, and that its loss resulted from their "sale in the regular course of its business."
On the first point petitioner sets forth its contention in its brief as follows:
It is the primary contention of the taxpayer that its transactions in refined oil futures were essentially a part of a process of production or other acquisition of property for sale to customers in the ordinary course of its trade or business. Correspondingly, we urge that we are not dealing with capital assets, and that losses sustained are not subject to those provisions of the Revenue Act of 1934 relating to capital losses. * * *
On brief the petitioner argues two grounds to justify its claims as a manufacturer of and/or dealer in refined cottonseed oil. The *261 first ground is based upon the theory that the manufacture of crude cottonseed oil, being the initial and first essential step in the manufacture of the refined product, makes the processor of the first a part manufacturer of the latter. It urges*1216 in further support of this theory that refined oil is crude oil subjected to further processing and that they are essentially the same commodity in a slightly different form, refined oil being the only commercially usable form, and that, therefore, they may be interchangeably carried as stocks in trade in its invoice. We think it unnecessary to consider the theory upon which this first ground is based, because the record negatives its application to petitioner's business. The positive proof here shows that the petitioner operated what is known as an "independent cotton seed mill" without connection with or interest in refineries or the business of refining cottonseed oil. Crude oil was but one of the several products of its mill and, as were its other products, was sold for cash. True, extracting the crude oil from the seed is a step in manufacture of refined cottonseed oil and the two processings might properly be carried on as a single business, but they are separate and distinct steps, performed with different equipment and machinery and each may be conducted as a business unto itself, separate and distinct from the other. The record shows that petitioner operates an independent*1217 mill and is in no sense a refiner of crude oil, and we so hold. We also hold against petitioner's view that crude cottonseed oil and the refined product are essentially one and the same commodity. Petitioner cites G.C.M. 1582, (C.B. VI-1, p. 171) to support its contention that refined products may be carried in the invoice of the producer of the crude from which it was manufactured, in substitution for the latter, but that ruling has no application to our facts. The ruling dealt with the case of a copper mining company which exchanged its mine output of crude ore currently as mined for prices payable in copper metal from a smelting company which bought and refined the ore. The taxpayer (mining company) there derived its income from sales of the metal received for its ore and maintained regular sales agencies for disposal of the same. Being an active dealer in refined copper, upon an accrual basis, the ruling consistently held that that taxpayer should include in its year-end invoice, as accounts receivable for copper "in kind" at then market prices, all undelivered copper owing to it by the smelting company. We agree with that ruling but find no support for petitioner's*1218 position in it. The petitioner next argues that the established custom of its business, as followed by it and other operators of "independent cotton seed mills", justifies transactions in refined oil futures, as here carried on by it as necessary to a stabilization of marketing its crude oil. Under the facts here petitioner *262 asserts that its purchases of refined oil futures amounted to "the purchase of refined oil" or "a purchase of property for sale to customers in the ordinary course of its business."
Whatever justification the entering into of these transactions may have had from the standpoint of business necessity or custom, it is clear from the record that petitioner acquired through them no property which it held for sale to customers. It contends that the contracts amounted to purchase of refined oil, but we think otherwise. Such transactions were mere executory contracts to purchase, which it acquired with a positive intent not to close into completed purchases and not to acquire any specific commodity through them. Such conclusion as to petitioner's intent in the premises in inescapable from explanations made by its manager while testifying at the*1219 hearing. Typical is the answer made by the witness to a question asking him to explain the oft-repeated statement to the effect that through these transactions in futures crude oil sold was replaced by refined oil. The question and answer are as follows:
MEMBER: You talked about replacing it with refined oil. Do you take delivery, actual delivery, of the refined oil that you bought on futures?
WITNESS: No, sir, we did not. That would put us back in about the same position as if we would have the refined. we would have the actual oil on hand, which we would have to buy, and it is cheaper to carry it in the crude than in the refined oil.
That in such transactions the petitioner was speculating on the ultimate liquidation of its contracts, and not on commodities "in kind", in shown from these further answers of the witness to questions as follows:
MEMBER: You made a settlement of these futures purchases on the basis of the difference in the market price at the effective date of the futures purchased, and the price you paid for it?
WITNESS: Of course, you have the right to demand delivery, and if you do not want delivery, if at that time there was a satisfactory market*1220 on which to sell that contract, we would sell it, but otherwise if it was not, we might transfer it into a forward position which we do at times, still further. At the final date you do take your loss or your profit, whichever it is.
MEMBER: And your losses involved in this proceeding are losses that were sustained by reason of your transactions in these futures?
WITNESS: That is right.
In such cases it is "intent" which determines the character of transactions. United States v. Amalgamated Sugar Co., 72 Fed.(2d) 755; Marengo Abstract Co. v.Hooper & co.,174 Ala. 497">174 Ala. 497; 56 So. 580">56 So. 580; Shannon v. McClung,210 Ala. 273">210 Ala. 273; 97 So. 840">97 So. 840; Smigh et al. v. Odell,21 Ala. App. 358">21 Ala.App. 358; 108 So. 400">108 So. 400; Willard Pope,28 B.T.A. 1255">28 B.T.A. 1255. Petitioner cites the latter case and also United States v. Amalgamated Sugar Co., supra, in support of its contention, but in *263 each of those cases the facts differed fundamentally from the facts here and the decisions therein sustain the legal principle respecting "intent" which we here apply. *1221 The petitioner at no time during the taxable year acquired or held refined cottonseed oil for sale to customers in the regular course of its business or at all. We hold against it upon that contention.
The petitioner advances another ground for claiming these losses as related to its mill business. It claims that transactions in refined oil futures, as here carried out, supply a needful protection to such business to the same end and purpose that a business "hedge" serves manufacturers and dealers in like situations. The petitioner, in its briefs, disclaims any contention that its transactions in controversy are within all requirements of a technical business hedge, but argues in effect that they fulfill all substantial requirements of hedges, subserve the same purpose, and are as legally applicable to its business, and, therefore, should be treated under the same rule in case of losses. Reduced to its essence petitioner's contention here is that necessity and custom made transactions in refined oil futures a regular part of its ordinary business. In our opinion the record does not support such claim. True, the evidence shows that in marketing its crude oil the petitioner's*1222 business was in need of protection against fluctuating prices, but it is obvious that transactions entered into after its raw stocks were bought, processed, the crude extracted and sold, and profits or losses attributable to it made determinable, could serve no such purpose. While the purpose of the transactions in refined oil futures contracts was to counterbalance the market hazards in relation to crude oil, such transactions were independent of the petitioner's crude oil marketing operations and involved their own hazard of losses and chance of gain. Petitioner's "forward" purchases were not made when its raw stocks were acquired and its investment therein put at risk in its business. They were made after such stocks were liquidated and the turn-over in capital invested therein was complete. The transactions in futures contracts were entered into for profit, subject to the risk of loss instead of gain, but the gain or loss realized thereon in no way resulted from or was attributable to petitioner's operations in buying its raw materials, processing same, and marketing its products. The amount of gain or loss realized by petitioner on the sale of crude oil did not affect and*1223 was not affected by the amount of gain or loss realized by it on its transactions in refined oil futures.
We hold that petitioner's transactions in refined oil futures contracts were not a part of its business as operator of its cottonseed oil mill.
*264 Referring to the remaining contention of petitioner we agree that its loss here in question resulted from transactions entered into for profit during the taxable year, and that they were not compensated for by insurance or otherwise, but this does not dispose of the issue in its favor. Petitioner's loss resulted from sale of contracts in futures which respondent contends were capital assets under section 117, supra. Subdivision (b) of that section defines as "capital assets" all property held by a taxpayer except (1) stock in trade of the taxpayer, (2) other property which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, and (3) property held by the taxpayer primarily for sale to customers in the ordinary course of business.
It is readily apparent from the facts here that the futures contracts were neither stock in trade of petitioner nor held by it for sale*1224 to customers in the ordinary course of business. This being true, they would not properly be includable in petitioner's inventory if on hand at the close of the taxable year.
Regardless of whether petitioner's transactions in such futures contracts constituted a trade or business, such contracts were nevertheless capital assets within the definition of section 117(b), supra. Such contracts were choses in action bought and sold only on a produce exchange through brokers. Petitioner bought and sold such futures contracts on its own account only and not for customers. It held no oil futures in stock for sale to customers and, therefore, had no right to include them in an inventory. Cf. Francis M. Weld,31 B.T.A. 600">31 B.T.A. 600; Adirondack Securities Corporation,23 B.T.A. 61">23 B.T.A. 61; Oil Shares, Inc.,29 B.T.A. 664">29 B.T.A. 664. We sustain respondent's determination herein.
Decision will be entered for the respondent.