FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
HENRY SAMUELI; SUSAN F. SAMUELI,
Petitioners-Appellants,
No. 09-72457
v.
Tax Ct. No.
COMMISSIONER OF INTERNAL 13953-06
REVENUE,
Respondent-Appellee.
PATRICIA W. RICKS; THOMAS G.
RICKS,
No. 09-72458
Petitioners-Appellants,
v. Tax Ct. No.
14147-06
COMMISSIONER OF INTERNAL
OPINION
REVENUE,
Respondent-Appellee.
Appeals from a Decision of the Tax Court
Argued and Submitted
July 21, 2011—San Francisco, California
Filed September 15, 2011
Before: A. Wallace Tashima and Johnnie B. Rawlinson,
Circuit Judges, and Jed S. Rakoff, Senior District Judge.*
*The Honorable Jed S. Rakoff, Senior United States District Judge for
the Southern District of New York, sitting by designation.
17597
17598 SAMUELI v. CIR
Opinion by Judge Tashima;
Concurrence by Judge Rawlinson
SAMUELI v. CIR 17601
COUNSEL
Richard M. Lipton, Baker & McKenzie, Chicago, Illinois, for
the petitioners-appellants.
17602 SAMUELI v. CIR
Bethany B. Hauser, Tax Division, U.S. Department of Justice,
Washington, DC, for the respondent-appellee.
OPINION
TASHIMA, Circuit Judge:
This case requires us to decide whether a purported securi-
ties loan with a fixed term of at least 250 days and possibly
as long as 450 days, entered into not for the purpose of pro-
viding the borrower with access to the lent securities, but
instead for the purpose of avoiding taxable income for the
lender, qualifies for nonrecognition treatment as a securities
loan pursuant to § 1058 of the Internal Revenue Code (the
“Code”), 26 U.S.C. § 1058.1 We hold that it does not.
I. BACKGROUND
A. Statutory Background
As a general rule, any sale or other disposition of property
is a taxable event. § 1001(c). Prior to 1978, there was some
uncertainty regarding the application of this general rule to
so-called securities lending transactions. These transactions
were developed in response to the needs of securities brokers,
who frequently faced delays in obtaining securities to deliver
to purchasers and therefore were forced to borrow the
required securities from organizations and individuals who
held such securities in their investment portfolios. See S. Rep.
95-762 (“Senate Report”), at 3-4 (1978), reprinted in 1978
U.S.C.C.A.N. 1286, 1289. In 1926, the Supreme Court had
held that the passage of securities from lender to borrower
pursuant to a securities lending agreement, and then back
again from borrower to lender at the end of the loan term,
1
All subsequent references and citations to a code section are to the
Internal Revenue Code, title 26, United States Code.
SAMUELI v. CIR 17603
were taxable events. Provost v. United States, 269 U.S. 443,
459 (1926). Subsequent rulings by the Internal Revenue Ser-
vice (the “IRS”), however, had taken the opposite position
and declared that these transactions were not taxable events.
E.g., Rev. Rul. 57-451, 1957-2 C.B. 295, 1957 WL 11085.
In 1978, Congress sought to clear up this confusion by
enacting § 1058, which provides that securities lending trans-
actions will not be treated as taxable dispositions. The Senate
Finance Committee recognized that such transactions are “de-
sirable” because they reduce the chances that brokers will fail
to deliver securities to purchasers within the time required by
the relevant market rules. Senate Report at 5, 1978
U.S.C.C.A.N. at 1291. Under § 1058, when a taxpayer trans-
fers securities under an agreement that meets certain enumer-
ated requirements, “no gain or loss shall be recognized on the
exchange of such securities by the taxpayer for an obligation
under such agreement, or on the exchange of rights under
such agreement by that taxpayer for securities identical to the
securities transferred by that taxpayer.” § 1058(a).
In order to qualify for nonrecognition under § 1058(a), an
agreement must:
“(1) provide for the return to the transferor of securi-
ties identical to the securities transferred;
(2) require that payments shall be made to the trans-
feror of amounts equivalent to all interest, dividends,
and other distributions which the owner of the secur-
ities is entitled to receive during the period begin-
ning with the transfer of the securities by the
transferor and ending with the transfer of identical
securities back to the transferor; [and]
(3) not reduce the risk of loss or opportunity for gain
17604 SAMUELI v. CIR
of the transferor of the securities in the securities trans-
ferred.”2
§ 1058(b).
B. Factual Background3
Petitioners in this case are Henry and Susan Samueli and
Thomas and Patricia Ricks (collectively, “Taxpayers”). Both
the Samuelis and the Rickses are married couples who filed
joint income tax returns for 2001 and 2003. Henry Samueli is
the billionaire co-founder of Broadcom Corporation, and
Thomas Ricks is an investment advisor to the Samuelis.4
In 2000 and 2001, the Samuelis’ accountant and tax consul-
tant, Arthur Andersen LLP, and Twenty First Securities, a
brokerage and financial firm, jointly designed and marketed
to the Samuelis a transaction that was predicated on the
expectation that short-term interest rates were going to fall
from their then-current levels. After evaluating memoranda
prepared by Twenty-First Securities, Thomas Ricks recom-
mended to the Samuelis that they invest in the proposed trans-
action, and they elected to do so. Thomas Ricks later became
a participant in the transaction as well when he acquired a
0.2% stake in it from another pass-through entity affiliated
with the Samuelis.
In its economic essence, the transaction consisted of Tax-
payers purchasing a security with a fixed rate of return deter-
2
Section 1058(b)(4) provides that the agreement must also “meet such
other requirements as the Secretary may by regulation prescribe,” but no
such regulations have been promulgated.
3
This case was tried on a stipulated set of facts. Thus, none of the facts
are controverted.
4
The entity that actually became a party to the transactions at issue here
is The Shiloh Trust (“Shiloh”), the Samuelis’ grantor trust, which is a dis-
regarded entity for federal income tax purposes; we refer to Shiloh and
Taxpayers interchangeably in this opinion.
SAMUELI v. CIR 17605
mined by interest rates at the time of purchase, and paying for
that purchase at a price derived from a variable interest rate.
However, the transaction as executed was considerably more
complex than that description and is best understood as a
series of discrete steps.
1. Step One: Purchase of the Securities; Margin
Loan
On October 17, 2001, Taxpayers purchased a $1.7 billion
principal “strip”5 (the “Securities”) issued by the Federal
Home Loan Mortgage Corporation (“Freddie Mac”) from
Refco Securities LLC (“Refco”), a securities broker. By pur-
chasing a strip, Taxpayers were purchasing the right to
receive the principal on a Freddie Mac bond at the date of
maturity but not the right to receive interest payments on that
bond prior to maturity. The Securities had a maturity date of
February 18, 2003, on which date their holder had the right
to receive $1.7 billion. Taxpayers purchased the Securities for
$1.643 billion, which meant that cashing in the Securities for
their par value on the maturity date would provide them with
an annual yield of 2.5810% on the purchase price.
Taxpayers funded the purchase of the Securities with a
margin loan (the “Margin Loan”) from Refco. The interest
rate of the Margin Loan was set at the variable London Inter-
bank Offering Rate (“LIBOR”) plus 10 basis points.6 The
Margin Loan was secured by the Securities, and Taxpayers
also deposited $21,250,000 with Refco as a condition of
obtaining the Margin Loan.
5
“Strip” is an acronym for “Separate Trading of Registered Interest and
Principal.”
6
One basis point equals one-one hundredth of a percentage point.
17606 SAMUELI v. CIR
2. Step Two: Loan of the Securities
The plan all along had been for Taxpayers to lend the
Securities back to Refco after purchasing them. On or about
October 11, 2001, six days before Taxpayers’ purchase of the
Securities, Taxpayers and Refco had entered into a Master
Securities Loan Agreement and an Amendment to the Master
Securities Loan Agreement (together, the “Loan Agreement”).
The Loan Agreement was on a standard form for securities
loan agreements. Taxpayers and Refco then entered into an
Addendum to the Loan Agreement (the “Addendum”) on
October 17, the same day that Taxpayers purchased the Secur-
ities.
The Loan Agreement required Taxpayers, as lender, to
transfer the Securities to Refco, as borrower. In return, Refco
would transfer to Taxpayers collateral with a market value at
least equal to that of the Securities. Taxpayers were required
to pay Refco a fee (the “Cash Collateral Fee”) equal to an
agreed-upon percentage of the amount of any such collateral
in cash. Refco also was required to “mark to market” the col-
lateral on a daily basis, meaning that if the market value of the
Securities went up on any given day, Refco was required to
transfer additional collateral to Taxpayers no later than the
close of the next business day, so that the market value of the
collateral remained equal to the market value of the Securi-
ties. The Loan Agreement also provided that Taxpayers could
terminate the loan of the Securities at any time, in which
event Refco would be required to return the Securities no later
than the third business day following notice of termination.
All of these terms are standard features of securities lending
agreements. See Senate Report at 5-6, 1978 U.S.C.C.A.N. at
1291.
The Addendum, however, was a customized document and
overrode several of the terms in the Loan Agreement. The
provision in the Loan Agreement permitting Taxpayers to ter-
minate the loan and demand return of the Securities on three
SAMUELI v. CIR 17607
business days’ notice was superseded by a section of the
Addendum entitled “Term of Specified Loan.” This section
provided that the loan would terminate on January 15, 2003
(approximately one month before the maturity date of the
Securities), unless Taxpayers elected to terminate it on either
July 1, 2002, or December 2, 2002. The Addendum also spec-
ified that, beginning on November 5, 2001, the Cash Collat-
eral Fee would be set at one-month LIBOR plus ten basis
points (the same rate as the interest rate under the Margin
Loan) and would be re-calculated on the first Monday of each
month. The Cash Collateral Fee would “be deemed to be
added to the Collateral held by” Taxpayers and would be paid
by Taxpayers to Refco when they returned the collateral to
Refco at the end of the loan term, unless Taxpayers elected to
pay the Cash Collateral Fee, “in whole or in part, prior to ter-
mination” of the loan. Finally, the Addendum provided that
Taxpayers would retain a deposit of $21,250,000 (the same
amount required to secure the Margin Loan) in an account
with Refco and would grant Refco a security interest in those
funds to secure the performance of Taxpayers’ obligations
under the Loan Agreement.
On October 19, 2001, two days after they purchased the
Securities, Taxpayers transferred the Securities to Refco as
required by the Loan Agreement. At the same time, Refco
provided Taxpayers with cash collateral of $1.643 billion (the
value of the Securities), which Taxpayers then used to pay off
the Margin Loan.
3. Step Three: 2001 Fee Payment
On December 28, 2001, Taxpayers determined that the
accrued Cash Collateral Fee at that time was $7.8 million, and
they wired that amount (the “2001 Fee Payment”) to Refco.
Approximately two weeks later, Refco returned an identical
amount to Taxpayers. This amount was recorded as an
increase in the amount of the cash collateral held by Taxpay-
ers.
17608 SAMUELI v. CIR
In December 2002, a representative of Twenty-First Securi-
ties discussed with Thomas Ricks the possibility of Taxpayers
paying Refco approximately $32 million in accrued Cash Col-
lateral Fee. The representative stated that “two weeks from
the date the wire is initiated, the money can be returned to
The Shiloh Trust.” But Taxpayers did not end up making such
a payment in 2002.
4. Step Four: Termination of the Loan
Taxpayers did not exercise their option to terminate the
loan in July or December 2002. Accordingly, the transaction
terminated on January 15, 2003, as provided for in the Adden-
dum. What happened upon termination, according to Taxpay-
ers, was that Refco purchased the Securities from Taxpayer
for the market price of $1.698 billion. Taxpayers owed Refco
$1.684 billion (the amount of the cash collateral plus accrued
Cash Collateral Fee). The amounts owed were settled via off-
set, so the only cash that changed hands at this point was
$35.3 million transferred from Refco to Taxpayers on January
16, 2003. This amount was the sum of $13.6 million in actual
economic gain for Taxpayers (the excess of the price Refco
paid Taxpayers for the Securities over the amount Taxpayers
had to return to Refco for the collateral), the return of the
Taxpayers’ $21.25 million deposit, and accrued interest on
that deposit of just over one-half million dollars.
C. Dispute over Tax Characterization; Procedural
Background
On their tax returns for 2001 and 2003, Taxpayers treated
the transaction as a securities loan under § 1058. Accordingly,
they assumed that their transfer of the Securities to Refco pur-
suant to the Loan Agreement, and Refco’s return of the Secur-
ities when the Loan Agreement expired, were not taxable
events. Instead, they: (1) treated the Securities as an asset that
they acquired in October 2001 for the purchase price and dis-
SAMUELI v. CIR 17609
posed of in January 2003 for the then-market value; and (2)
treated the Cash Collateral Fee as interest paid by them to Refco.7
Accordingly, on their 2001 returns, Taxpayers claimed an
interest deduction for the 2001 Fee Payment in the amount of
$7.8 million. (The Samuelis claimed $7,796,903, or 99.8 per-
cent of the total, while the Rickses claimed the remaining 0.2
percent, or $15,667.) On their 2003 return, the Samuelis
reported $50,661,926 in long-term capital gain from the sale
of the Securities to Refco. This amount represented the pro-
ceeds of the sale ($1.697 billion) less the purchase price of the
Securities ($1.643 billion), and less transaction costs of $3.56
million, further adjusted to deduct the Rickses’ ownership
interest in the Securities. The Samuelis also claimed an inter-
est deduction for $32,792,720, which was the amount of Cash
Collateral Fee that had accrued on the termination date and
was paid to Refco along with the original amount of the Cash
Collateral (the “2003 Fee Payment”). (The Rickses did not
claim any interest deduction in connection with the termina-
tion of the transaction.)
The Commissioner of Internal Revenue (the “Commission-
er”) rejected this characterization of the transaction. The
Commissioner determined that the transaction did not in fact
qualify as a securities lending arrangement under § 1058 and
instead adopted his own interpretation of the transaction, as
7
Fees paid with respect to cash collateral in securities lending arrange-
ments traditionally are treated as interest, despite the fact that this creates
a counterintuitive situation in which the lender of securities is paying
interest to the borrower. The assumption that fees paid on cash collateral
are deductible as interest does not have an entirely clear foundation in the
law. But neither is there any clear reason to challenge that assertion. The
Supreme Court in Provost described the fee payments as “interest,” 269
U.S. at 452, and the IRS, in a private letter ruling issued not long after
§ 1058 was passed, described fees paid on cash collateral as “substantially
similar” to interest, Priv. Ltr. Rul. 8011100, 1979 WL 53605 (Dec. 21,
1979). In this case, we need not confront the issue of whether this conven-
tional treatment of cash collateral fees as interest is justified.
17610 SAMUELI v. CIR
follows: In October 2001, Taxpayers purchased the Securities
from Refco for the purchase price ($1.643 billion) and imme-
diately sold them back to Refco for the amount of the cash
collateral (also $1.643 billion). Then, in January 2003, Tax-
payers purchased the Securities from Refco a second time
pursuant to a “forward contract.” The price for this second
purchase was the amount of the cash collateral plus accrued
Cash Collateral Fee ($1.684 billion). Immediately after this
second purchase of the Securities, Taxpayers again sold them
back to Refco, this time for their then market value ($1.698
billion). Accordingly, the Commissioner determined that Tax-
payers: (1) had no capital gain or loss in 2001 (because they
sold the Securities for the same price at which they had pur-
chased them); (2) had $13.54 million in short-term capital
gain in 2003;8 and (3) could not deduct the Cash Collateral
Fee payments as interest expense in either year, because no
indebtedness ever existed.
Accordingly, in April 2006, the Commissioner issued a
Notice of Deficiency for tax years 2001 (in the amount of
$2,177,532) and 2003 (in the amount of $171,026) to the
Samuelis, and a Notice of Deficiency for tax year 2001 (in the
amount of $6,126) to the Rickses. Both the Samuelis and the
Rickses filed petitions with the Tax Court seeking redetermi-
nation of the deficiencies.9 Each of Taxpayers and the Com-
missioner moved for summary judgment; the Tax Court
granted the Commissioner’s motion. See Samueli v. Comm’r,
132 T.C. 37 (2009). Taxpayers timely appealed.
8
Long-term capital gain may be reported only if an asset is held for
more than one year. Gain from the sale of an asset held for one year or
less is considered short-term capital gain. §§ 1222(1), (3). Long-term capi-
tal gain is taxed at a more favorable rate than short-term capital gain.
9
Upon the joint motion of Taxpayers, the Tax Court consolidated the
two petitions.
SAMUELI v. CIR 17611
II. DISCUSSION
A. Jurisdiction
The Tax Court had jurisdiction over Taxpayers’ petitions
for redetermination of deficiency pursuant to §§ 6214(a) and
7442. We have jurisdiction over appeals from decisions of the
Tax Court under § 7482(a)(1).
B. Standard of Review
We review the Tax Court’s interpretation of the Code and
its legal conclusions de novo. Teruya Bros., Ltd. v. Comm’r,
580 F.3d 1038, 1043 (9th Cir. 2009). The application of the
law to a stipulated factual record, as is presented here, is also
reviewed de novo. Sennett v. Comm’r, 752 F.2d 428, 430 (9th
Cir. 1985).
C. Section 1058(b)(3)
[1] The Tax Court found that the transaction did not qual-
ify for nonrecognition under § 1058 because the Loan Agree-
ment and Addendum failed to meet the requirement of
§ 1058(b)(3) that a transaction “not reduce the . . . opportunity
for gain of the transferor of the securities in the securities
transferred.” According to the Tax Court and the Commis-
sioner, the transaction failed to meet this requirement because
the Addendum permitted Taxpayers to terminate the loan only
on one of three dates (July 1, 2002, December 1, 2002, or Jan-
uary 15, 2003), which limited their ability to profit from any
short-term increase in the value of the Securities (by reclaim-
ing and selling the Securities) that occurred on any date dur-
ing the term of the loan, other than the two dates specified in
the Addendum. Taxpayers challenge this conclusion
(although, as discussed further below, they also contend that
§ 1058 is not determinative of or even necessarily relevant to
the outcome in this case). We agree with the Tax Court’s con-
17612 SAMUELI v. CIR
clusion that the transaction did not meet the requirements of
§ 1058.
[2] The plain language of § 1058(b)(3), with the gloss pro-
vided by elementary economic analysis, supports the Tax
Court’s conclusion on this point. Taxpayers relinquished all
control over the Securities to Refco for all but two days in a
term of approximately 450 days. During this period, Taxpay-
ers could not have taken advantage of a short-lived spike in
the market value of the Securities, because they had no right
to call the Securities back from Refco and sell them at that
increased price until several months later. Common sense
compels the conclusion that this reduced the opportunity for
gain that a normal owner of the Securities would have
enjoyed.
[3] The terms of the Addendum reduced Taxpayers’ upside
exposure to the market value of the Securities in another way
as well, which was not highlighted by the Tax Court in its
decision. Per the Addendum, if Taxpayers had elected to ter-
minate the loan on either of the two optional early termination
dates, Refco would have had the right to purchase the Securi-
ties at a LIBOR-based price. On both such dates, the LIBOR-
based formula ended up yielding a price that was higher than
the trading price for the Securities. This means that in all like-
lihood Refco would not have exercised its right to purchase
the Securities if Taxpayers had terminated the transaction on
either such date, assuming the same securities were readily
available from other sellers. However, had interest rates
moved in a different direction, the LIBOR-based formula
could have yielded a price that was lower than the trading
price. If this had been the case, Taxpayers could only have
terminated the transaction on one of those dates at the risk of
being forced to sell the Securities to Refco for less than their
market price. In effect, this further reduced Taxpayers’ ability
to exit the transaction at will.
Taxpayers argue that their inability to secure the return of
the Securities on demand did not affect their ability to recog-
SAMUELI v. CIR 17613
nize gain because the Securities were “zero-coupon bonds
whose value [did] not widely fluctuate with windfall profits
at some momentary period.” This argument is superficially
convincing. But it is not a sufficient basis for finding that this
transaction did comply with § 1058(b)(3). First, the value of
the Securities would not need to fluctuate “widely” during the
term of the loan to provide opportunities to sell at a profit;
when one owns $1.6 billion of a particular security, even a
small fluctuation in value can produce a significant opportu-
nity, in absolute terms, for profit. Second, as noted above,
even if one could assume that there was zero risk of any fluc-
tuation in the market value of the Securities, Refco’s option
to purchase the Securities at the LIBOR-based prices still
affected Taxpayers’ ability to realize the market price of the
Securities on the dates when they had the option of getting
them back from Refco. Finally, the assumption that the mar-
ket price of the Securities — Freddie Mac bonds — will never
fluctuate widely or unexpectedly seems less valid today than
it may have when Taxpayers invested in the Securities. See,
e.g., Suffering a Seizure: America’s government takes control
of Freddie Mac and Fannie Mae, The Economist, Sep. 8,
2008, available at http://www.economist.com/node/
12078933?story_id=12078933 (describing the 2008 federal
government takeover of Freddie Mac as being motivated in
part by the imperative to maintain the value of its debt securi-
ties).
[4] Taxpayers point to another section of the Code to sup-
port their interpretation of § 1058(b)(3) as accommodating the
transaction at issue here. Simultaneously with the enactment
of § 1058, Congress amended § 512(b)(1) to provide that
“payments with respect to securities loans” received by tax-
exempt organizations would not be treated as “unrelated busi-
ness taxable income.” Section 512(a)(5)(A) clarifies that the
phrase “payments with respect to securities loans” means “all
amounts received in respect of a security . . . transferred by
the owner to another person in a transaction to which section
1058 applies,” while § 512(a)(5)(B) further clarifies that such
17614 SAMUELI v. CIR
transactions must also be pursuant to an agreement which pro-
vides for:
(i) reasonable procedures to implement the obliga-
tion of the transferee to furnish to the transferor, for
each business day during such period, collateral with
a fair market value not less than the fair market value
of the security at the close of business on the preced-
ing business day,
(ii) termination of the loan by the transferor upon
notice of not more than 5 business days, and
(iii) return to the transferor of securities identical to
the transferred securities upon termination of the
loan.
§ 512(a)(5)(B).
[5] The requirements of § 512(a)(5)(B) are in addition to
the requirement in § 512(a)(5)(A) that a transaction comply
with the terms of § 1058. Taxpayers argue that interpreting
§ 1058(b)(3) as requiring that agreements give lenders the
right to a return of their securities on demand renders super-
fluous the requirement of § 512(a)(5)(B)(ii) that a securities
lending agreement must provide for “termination of the loan
by the transferor upon notice of not more than 5 business
days.” It is true that courts generally should be “hesitant to
adopt an interpretation of a congressional enactment which
renders superfluous another portion of that same law.”
Mackey v. Lanier Collection Agency & Serv., Inc., 486 U.S.
825, 837 (1988). But Taxpayers’ argument is unconvincing
for several reasons.
First, it is apparent that avoiding redundancy was not a
major goal of Congress when it drafted §§ 1058 and
512(a)(5): the requirements of § 1058, incorporated by refer-
ence into § 512(a)(5), include the requirement that the securi-
SAMUELI v. CIR 17615
ties lending agreement “provide for the return to the transferor
of securities identical to the securities transferred.”
§ 1058(b)(1). But, redundantly, that requirement is then
repeated in § 512(a)(5)(B)(iii) (the agreement must provide
for the “return to the transferor of securities identical to the
transferred securities upon termination of the loan”).
Second, Taxpayers’ argument ignores the distinction
between the requirement that a transaction be terminable upon
demand, and a definition of what terminable upon demand
means. Section 512(a)(5)(B)(ii) provides the latter: it requires
that securities be subject to return within five business days of
the lender’s request. The specification that the notice period
be five business days was derived from then-current Securi-
ties and Exchange Commission (“SEC”) rules governing the
lending of securities by regulated investment companies.
Those rules had required that the lender be able to terminate
the loan with five business days’ notice. See Senate Report at
5-6, 1978 U.S.C.C.A.N. at 1291. These rules in turn derived
their required notice period from SEC rules establishing five
business days as the standard settlement time frame for most
broker-dealer trades in securities. See Securities Transactions
Settlement, 59 Fed. Reg. 59,137 (Nov. 16, 1994), 1994 WL
637524 (describing implementation schedule for the “conver-
sion to a T+3 settlement environment” from the “T+5” settle-
ment time frame previously in effect).
[6] There is a good reason why the notice period for termi-
nation of a securities loan should be the same as the settle-
ment period for sales of securities: if a lender entered into a
contract to sell a security that he had loaned to another party,
the five-business-day settlement period would mean that he
would need to deliver the security to the purchaser within five
business days of the contract, so the requirement that the bor-
rower return the security within five business days of notice
ensured that the lender would have the security available to
deliver to the purchaser on time. In 1994, the SEC amended
its regulations to provide that brokers or dealers needed to
17616 SAMUELI v. CIR
deliver most securities within three business days of the pur-
chase or sale contract. See id.; 17 C.F.R. § 240.15c6-1(a)
(1994). Accordingly, the standard notice period for termina-
tion of securities lending transactions shifted to three business
days, as is apparent from the standard form Loan Agreement
used in Taxpayers’ transaction. Because the standard notifica-
tion period for termination of a securities loan can vary,
§ 512(a)(5)(B)(ii) would not be superfluous even if
§ 1058(b)(3) implied a requirement that a securities loan be
terminable on demand, because § 1058(b)(3) still could be
read as permitting a notice period of longer than five days.
[7] Third, and most importantly, our conclusion that the
transaction at issue in this case reduced Taxpayers’ opportu-
nity for gain does not necessarily imply a conclusion that a
securities loan must be terminable upon demand to satisfy the
requirements of § 1058(b)(3). In 1983, the Department of the
Treasury considered adopting implementing regulations for
§ 1058 that would have incorporated the five-business-days
notice requirement. The proposed regulations were never
adopted, but the debate surrounding them is illuminating. Spe-
cifically, proposed 26 C.F.R. § 1.1058-1(b)(3) would have
provided that a qualifying agreement must “[n]ot reduce the
lender’s risk of loss or opportunity for gain. Accordingly, the
agreement must provide that the lender may terminate the
loan upon notice of not more than 5 business days.” Transfers
of Securities Under Certain Agreements, 48 Fed. Reg. 33912,
33913 (proposed July 26, 1983). In response to the proposed
regulation, the American Bar Association’s Committee on
Financial Transactions (the “ABA Committee”) issued a
report objecting to the requirement, in part because it would
prevent parties from lending securities for fixed terms longer
than five days. The ABA Committee advocated instead a
“facts and circumstances” test to address § 1058(b)(3) rather
than a bright-line rule and suggested that such a “facts and
circumstances” test should “take into account both the length
of time until the debt investment security matures and the
length of the time the security is borrowed.” ABA Committee
SAMUELI v. CIR 17617
Reports on Securities Lending Transactions (“ABA Report”),
91 Tax Notes Today 107-33 (May 15, 1991), Section IV.2.
The ABA Committee’s concern that § 1058 not be con-
strued in such a way as to exclude all loans for fixed terms
was echoed in a report that the Tax Section of the New York
State Bar Association (the “NYSBA Committee”) issued in
response to several recent decisions of the Tax Court, includ-
ing its decision now on appeal in this case. Report of the Tax
Section of the New York State Bar Association on Certain
Aspects of the Taxation of Securities Loans and the Operation
of Section 1058 (June 9, 2011) (“NYSBA Report”), at 10-11.
We are cognizant that a holding that no securities loan for a
fixed term can qualify for § 1058 nonrecognition “could
affect commonplace market transactions in a manner that
arguably violates the overarching policy of section 1058.” Id.
at 10. But we do not so hold today because the resolution of
this case does not require us to do so. First, as will be dis-
cussed more thoroughly in the next section of this opinion, we
believe this transaction falls outside “the overarching policy
of section 1058.” Second, the transaction at issue here would
fail the “facts and circumstances” test that the ABA Commit-
tee proposed as an alternative to a rule that would exclude all
fixed-term loans from the scope of § 1058. Taxpayers’ inabil-
ity to terminate the loan except on one of three dates is clearly
not “consistent with the continued evolution of commercial
practices,” ABA Report, Section IV.2, because the current
standard practice for loans of bonds like the Securities is to
allow termination by the lender on three days’ notice (as is
evidenced by the terms of the standard form Loan Agreement
in this transaction, which were overriden by the Addendum).
The length of the loan term under the Addendum (approxi-
mately 450 days), the fact that the loan term extended almost
to the maturity date of the Securities, and Taxpayers’ inability
to terminate the loan on any but two dates during that term all
severely hampered Taxpayers’ ability to take advantage of
market fluctuations in the price of the Securities. Moreover,
Refco’s option to purchase the Securities at the LIBOR for-
17618 SAMUELI v. CIR
mula price meant that Taxpayers’ ability to liquidate the
Securities at the actual market price was limited even further.
[8] As the NYSBA noted, the question of whether securi-
ties loans for shorter fixed terms, made for the purposes ani-
mating § 1058, qualify for nonrecognition treatment is more
appropriately settled by further guidance from the Department
of the Treasury and the IRS. NYSBA Report, at 10. The pres-
ent case does not require us to settle this question; thus, we
decline to address it.
D. Proper Characterization and Tax Treatment of the
Transaction
Taxpayers also argue that, even if the transaction does not
qualify for nonrecognition under § 1058, their tax treatment of
the transaction was still correct. They make this argument in
several ways. First, they argue that their transaction was fac-
tually a securities loan that qualified for nonrecognition treat-
ment even if it did not meet the requirements of § 1058(b).
(Relatedly, they argue that the Tax Court’s characterization of
the transaction as two sets of purchases and sales is not sup-
ported by the facts of the transaction.) Second, they argue
that, even if the Tax Court’s characterization of the transac-
tion were correct, Taxpayers still reported its tax conse-
quences correctly.
1. Whether the Transaction Was Factually a
Securities Loan
As an initial matter, the parties dispute the baseline ques-
tion of whether a transaction may qualify as a securities loan
eligible for nonrecognition if it does not fulfill the require-
ments of § 1058(b). Taxpayers argue that the requirements of
§ 1058(b) merely create a “safe harbor” and do not delineate
the limits of what is considered a securities loan for tax pur-
poses. However, we need not decide today whether § 1058(b)
is a safe harbor or the only route to nonrecognition, because
SAMUELI v. CIR 17619
the facts of this case clearly indicate that this particular trans-
action does not fall within the category of transactions that
Congress sought to cover with § 1058.
The Tax Court, in characterizing the transaction as “in sub-
stance two separate sales of the Securities,” cited the well-
established principle that “[f]or Federal tax purposes, the
characterization of a transaction depends on economic reality
and not just on the form employed by the parties to the trans-
action.” Samueli, 132 T.C. at 52. See, e.g., Teruya Bros., Ltd.,
580 F.3d at 1043 (“[T]ax classifications turn on the objective
economic realities of a transaction rather than the particular
form the parties employed.”) (internal quotation marks and
punctuation omitted). We are cognizant of “the reality that the
tax laws affect the shape of nearly every business transaction”
and therefore will not recharacterize a transaction merely
because tax considerations were one motivation for its partic-
ular structure. Frank Lyon Co. v. United States, 435 U.S. 561,
580 (1978). However, we may recharacterize a transaction
that had “no business or corporate purpose” when “what was
done, apart from the tax motive, was [not] the thing which the
[relevant tax] statute intended.” Gregory v. Helvering, 293
U.S. 465, 469 (1935).
Taxpayers’ purchase of the Securities, and the funding of
that purchase by the Margin Loan, did have a non-tax busi-
ness or corporate purchase. That step of the transaction was
motivated by Taxpayers’ belief that interest rates would fall.
If interest rates were to fall (and they did), holding a security
that produced a return based on the interest rate at the time of
purchase, and financing that purchase with a loan charging a
variable rate, would result in a profit based on the difference
between the fixed rate and the variable rate.
If this were Taxpayers’ only goal, however, there would
have been no need for them to lend the Securities to Refco.
Had they not transferred the Securities to Refco, Taxpayers
clearly would have been able to secure the tax treatment for
17620 SAMUELI v. CIR
the transaction that they are arguing for here: they would have
held the Securities for more than one year and been able to
claim long-term capital gains upon their sale, and the interest
under the Margin Loan would have been deductible.
[9] The sole motivation for adding the purported securities
loan to the transaction was tax avoidance. As is explained in
marketing materials for the transaction produced by Twenty-
First Securities,10 if Taxpayers had simply bought and sold the
Securities, they would have been forced to report the yield on
the Securities as interest income (taxed at the highest rate)
even though they did not actually receive any payment until
the Securities matured. See § 1272(a)(1) (providing that the
“original issue discount” on debt instruments like the Securi-
ties “shall be included in the gross income of the holder”). As
the marketing materials explain, however, “when a taxpayer
loans a security to a borrower (such as a bond dealer) and cer-
tain criteria are met, then the taxpayer lending the security
will no longer be treated as the owner of the security for fed-
eral tax purposes” and will not be required to report such
interest income. The loan was thus conceived as a way for
Taxpayers to avoid interest income and generate, as the mar-
keting materials put it, “income taxed at favorable rates and
expenses deductible at the highest rate.”
Unlike a typical securities lending arrangement, this trans-
action was designed around minimizing Taxpayers’ tax bill
rather than around Refco’s need to have the Securities avail-
able to deliver to its customers. Taxpayers received no com-
pensation from Refco for the loan of the securities. They did
“receive” the cash collateral, but that was economically mean-
ingless, because the cash collateral was used to repay the
Margin Loan, so that Taxpayers never held it for their own
account or earned interest on it. The Cash Collateral Fee was
10
It is not clear from the stipulated record that Taxpayers themselves
actually saw these marketing materials before they decided to enter into
the transaction.
SAMUELI v. CIR 17621
identical to the interest rate under the Margin Loan, the
deposit required under the Addendum was the same as that
required for the Margin Loan, and Taxpayers used the cash
collateral to pay off the Margin Loan. Because of this, their
economic position vis-a-vis Refco was identical to what it
would have been absent the Loan Agreement and Addendum
except in one key respect: as discussed above, their ability to
profit from the sale of the Securities during the term of the
loan was severely compromised.
[10] Congress’ explicit goal in enacting § 1058 was to
encourage loans for the benefit of brokers who needed large
supplies of securities on hand to deliver to purchasers,
because such loans “can have a favorable impact on the
liquidity of securities markets.” Senate Report at 6, 1978
U.S.C.C.A.N. at 1292. It may be possible that nonrecognition
treatment should be given to a transaction that fails to meet
all of the specific requirements of § 1058(b), but that nonethe-
less is motivated by the goals that Congress had in mind when
it enacted § 1058. But this loan, a tax shelter marketed as such
for which the borrowing broker (Refco) did not pay the lender
any consideration, clearly was not “the thing which the statute
intended.” Gregory, 293 U.S. at 469. Indeed, even the ABA
Report favored the position that a loan transaction must share
the motivations indicated by Congress to receive nonrecogni-
tion treatment: the ABA Committee suggested that Treasury
issue a regulation “requir[ing] that a Section 1058 securities
loan be entered by the borrower for the purposes” which Con-
gress intended. ABA Report, Section IV.2.
[11] “Exceptions to the general rule requiring the recogni-
tion of all gains and losses on property dispositions are to be
‘strictly construed and do not extend either beyond the words
or the underlying assumptions and purposes of the excep-
tion.’ ” Teruya Bros., Ltd., 580 F.3d at 1043 (quoting 26
C.F.R. § 1.1002-1(b)). The purported loan at issue here does
not fit within the underlying assumptions and purposes of
17622 SAMUELI v. CIR
§ 1058 and should not be afforded nonrecognition treatment
as a securities loan.
2. Whether Taxpayers Reported the Transaction
Correctly
Taxpayers’ second argument is that § 1058 is largely irrele-
vant and, that their tax treatment of the transaction was cor-
rect even if the transaction is not viewed as a securities loan
at all. Rather than the purchase and immediate resale of the
Securities, creating short-term capital gain, Taxpayers argue
that what really happened in 2003 was that they liquidated a
contractual right to receive the Securities from Refco (the
“Contractual Right”). The Contractual Right was a capital
asset that they acquired in consideration of their 2001 sale of
the Securities to Refco; their basis in it was the price that first
Taxpayers and then Refco paid for the Securities in 2001
($1.643 billion). Over a year later, in 2003, that asset was liq-
uidated when Refco paid Taxpayers the market value of the
Securities in lieu of delivering the actual Securities. The liqui-
dation of the capital asset yielded exactly the long-term capi-
tal gain that Taxpayers reported, not the short-term capital
gain that the Commissioner argues they should have reported.
[12] Taxpayers are correct that a contractual right of this
nature could be a capital asset under § 1221 and that gain
attributable to the cancellation or termination of such an asset
is capital gain under § 1234A, which provides that “[g]ain or
loss attributable to the cancellation, lapse, expiration, or other
termination of . . . a right or obligation . . . with respect to
property which is (or on acquisition would be) a capital asset
in the hands of the taxpayer . . . shall be treated as gain or loss
from the sale of a capital asset.” § 1234A. See also Wolff v.
Comm’r, 148 F.3d 186, 188 (2d Cir. 1998) (“[A] gain or loss
from the cancellation of a futures or forward contract would
result in capital gain or loss pursuant to [§ 1234A].”).
[13] The Commissioner in turn argues that Taxpayers’ the-
ory is valid only if the Contractual Right was “cancelled” or
SAMUELI v. CIR 17623
“terminated,” rather than merely fulfilled, in 2003. In other
words, if Refco actually did sell the Securities to Taxpayers
as the Contractual Right obligated them to do, there was no
cancellation or termination of the capital asset, and the Tax
Court’s interpretation of the 2003 events as yielding short-
term capital gain is correct. The Commissioner has the better
argument on this point. The Commissioner is correct that
there is nothing in the record to support the assertion that
Refco “cancelled” or “terminated” its contract with Taxpay-
ers. The Loan Agreement required Refco to return the Securi-
ties to Taxpayers, and there is no evidence in the record of
any discussion between them that would constitute an
acknowledgment that this obligation would not be met. The
parties also stipulated in the Tax Court that “Shiloh sold the
Securities to Refco” at that time, which Shiloh could not have
done if Refco had not first delivered the Securities to Shiloh
as Refco was required to do under the Contractual Right.
It is true that the Commissioner’s pointing to Taxpayers’
and Refco’s characterization of the events in 2003 is a bit dis-
ingenuous, because the Commissioner’s argument and the
Tax Court’s position is that the labels the parties themselves
put on the transaction should be disregarded. But that does not
mean that Taxpayers therefore must have the right to call the
transaction whatever they want after the fact. It is also true
that the 2003 exchange was settled via offset, with Taxpayers
neither taking title to the Securities nor transferring any funds
to Refco. But given Taxpayers’ and Refco’s characterization
of the transaction as a securities loan and the fact that Taxpay-
ers never actually held the cash collateral in their account, it
would have been impossible for the 2003 exchange to be
structured otherwise. For example, a transfer of title to Tax-
payers in 2003 would have made no sense, because the parties
assumed that Taxpayers were already the owner of the Securi-
ties.
In addition, Taxpayers’ argument implies that the tax treat-
ment of a transaction like this one should be determined by
17624 SAMUELI v. CIR
the relatively trivial matter of whether the purported securities
lender received securities or cash equal to the market value of
the securities at the end of the loan term. If we were to agree
with Taxpayers’ argument, then parties to similar transactions
could obtain tax treatment equivalent to that which they
would have obtained under § 1058, despite not complying
with either the letter or the spirit of that provision, merely by
making sure that the broker gives the lender cash instead of
securities at the end of the term. (The lender could then use
that cash to purchase the same securities, if he wished to hold
them for a longer period.)
E. Interest Deductions
[14] As noted above, lenders in securities lending arrange-
ments who receive cash collateral from the borrower typically
pay an interest-equivalent fee on that collateral and deduct the
fee as interest. In effect, they act as both lender and interest-
paying borrower in the transaction. The Tax Court disallowed
Taxpayers’ interest deductions in this case because it deter-
mined that no loan of the Securities occurred in 2001 and that
the purported cash collateral on which the Cash Collateral Fee
was paid “represented the proceeds of the first sale and not
collateral for a securities loan.” Samueli, 132 T.C. at 53. The
Tax Court treated the question of whether Taxpayers’ interest
deductions should be allowed as largely dependent on the
analysis of whether the transaction qualified for § 1058 treat-
ment. Although the Tax Court’s ultimate conclusion was cor-
rect, this approach was in error.
[15] The Code permits taxpayers to deduct “all interest
paid or accrued within the taxable year on indebtedness.”
§ 163(a). Indebtedness is “an unconditional and legally
enforceable obligation for the payment of money,” Linder v.
Comm’r, 68 T.C. 792, 796 (1977), and is generally found to
exist if, at the time funds were advanced, the parties actually
intended that they would be repaid, Welch v. Comm’r, 204
F.3d 1228, 1230 (9th Cir. 2000). Interest, meanwhile, is
SAMUELI v. CIR 17625
defined in its typical business sense as “compensation for the
use or forbearance of money.” Deputy v. DuPont, 308 U.S.
488, 498 (1940). Taxpayers bear the burden of establishing
their entitlement to the interest deduction. Gatto v. Comm’r,
1 F.3d 826, 828 (9th Cir. 1993).
1. 2001 Fee Payment
[16] In order to address the 2001 Fee Payment, we do not
even need to reach the question of whether any indebtedness
existed, because the 2001 Fee Payment was not a bona fide
interest payment. The Tax Court correctly pointed out that
any obligation of Taxpayers to pay the Cash Collateral Fee at
any time other than the end of the loan term was entirely illu-
sory. The Addendum clearly provided that Taxpayers did not
need to pay the Cash Collateral Fee as it accrued; instead, it
would “be deemed to be added to the Collateral held by” Tax-
payers, unless they elected to make a payment at any time.
The amount of the 2001 Fee Payment was promptly refunded
to Taxpayers after it was made, ostensibly to supplement the
cash collateral, and Taxpayers were offered the opportunity to
make another fee payment close to the end of the 2002 tax
year, with the understanding that the money would be
promptly returned and added to the cash collateral as well.
[17] Interest payments that are made solely to reduce the
tax bill for the payer rather than for the benefit of and at the
behest of the payee clearly should not be considered compen-
sation to the payee for the use or forbearance of money. The
Tax Court astutely cited the so-called “Livingstone cases” in
its opinion. In those cases, the Tax Court and several courts
of appeals held that a series of tax-sheltered transactions in
which every purported interest payment by the taxpayer was
quickly followed by a refund of that amount by the lender did
not qualify for interest deductions. The Livingstone cases
stand for the principle that payments made in connection with
other payments that, together, “add up to zero” or “neutralize
one another” should not be honored for tax purposes. Rubin
17626 SAMUELI v. CIR
v. United States, 304 F.2d 766, 770 (7th Cir. 1962) (quoting
MacRae v. Comm’r, 34 T.C. 20 (1960)); see, e.g., Goodstein
v. Comm’r, 30 T.C. 1178, 1188-89 (1958) (a representative
Livingstone case disallowing interest payments that were off-
set by identical payments to the borrower and noting that
there was no non-tax reason for the payments to be made
when they were). See also Knetsch v. United States, 364 U.S.
361, 364-66 (1960) (disallowing interest deductions based on
the conclusion that the underlying loan was a sham, in large
part because all interest payments during the term of the loan
were largely returned to the taxpayer as additional borrowed
amounts, and the amount of equity which the taxpayer main-
tained in the asset which he had used the loan to purchase was
minimal).
An analogous principle is embodied in § 1091 of the Code,
which prevents taxpayers from claiming loss deductions on
“wash sales of stock or securities”: if a taxpayer sells shares
of stock and acquires or has acquired substantially identical
stock within thirty days before or after the sale, he is not per-
mitted to claim a deduction for any loss sustained on the sale.
§ 1091. If this rule did not exist, any taxpayer could effect a
sizable reduction in his tax bill at virtually no economic cost
to himself by selling stock worth less than what he paid for
it, thus incurring a loss deduction for tax purposes, and imme-
diately repurchasing it at the same price. To permit interest
deductions for payments under loan agreements that are made
at the borrower’s election and that are systematically restored
to the borrower within a week or two would lead to a simi-
larly absurd and problematic result.
2. 2003 Fee Payment
While the 2001 Fee Payment may have been a sham, we do
not agree with the Tax Court’s determination that no indebt-
edness existed on which interest might have accrued. The
problem with the Tax Court’s determination is that it ignores
the fact that the Margin Loan made the entire transaction pos-
SAMUELI v. CIR 17627
sible. The Tax Court’s characterization of events fails to
explain what happened to the Margin Loan. If it was paid off
with the proceeds of the 2001 sale of the Securities by Tax-
payers to Refco, then we are left with the question of where
Taxpayers got the funds to re-purchase the Securities in 2003.
The Tax Court’s interpretation of the transaction as not
involving indebtedness by Taxpayers to Refco makes sense
only if we assume that at some point Refco either forgave
over a billion dollars of debt owed them by Taxpayers or else
provided Taxpayers with a gift of securities worth the same
amount. (Either event should have produced taxable income
for Taxpayers.)
[18] If Taxpayers had simply left the Margin Loan out-
standing and paid (non-refundable) interest on that loan on a
regular schedule, they likely would have had no problem
making the case that the interest should be deductible. As
noted above, the cash collateral and the Cash Collateral Fee
were economically equivalent to the Margin Loan and the
interest thereon. Regardless of whether the purported loan of
the Securities was entitled to nonrecognition treatment under
§ 1058, and regardless of whether it was a true loan, a sale,
or something else, Refco did forbear from the use of money
when it purchased the Securities for Taxpayers’ benefit. See
DuPont, 308 U.S. at 498. It makes no economic sense to
assume that they did so for free. Unlike the 2001 Fee Pay-
ment, the 2003 Fee Payment did come out of Taxpayers’
pocket, albeit indirectly (it reduced the amount that they
received with respect to the Securities in that year).
[19] Therefore, the Tax Court erred in disallowing the
deduction of the 2003 Fee Payment. Moreover, the amount of
the 2001 Fee Payment should be added to the amount that
Taxpayers should have been permitted to deduct in 2003,
because the fact that the 2001 Fee Payment was a sham does
not change the fact that the amount paid was ultimately owed
to Refco.
17628 SAMUELI v. CIR
[20] This error, however, did not make a difference in the
ultimate determination of deficiency. In calculating the 2003
deficiency, the Tax Court treated the full amount of the cash
collateral and the Cash Collateral Fee as Taxpayers’ basis in
the Securities. The payment of the Cash Collateral Fee can be
either part of the 2003 purchase price for the Securities or an
interest payment to Refco, but it cannot be both. Therefore, if
the Cash Collateral Fee were deductible as interest, Taxpay-
ers’ 2003 basis in the Securities would need to be reduced by
the amount of the deductible interest. This means that Tax-
payers’ short-term capital gain in 2003 would increase by the
same amount. Because short-term capital gain is taxed at ordi-
nary income rates, there would be no change in the deficiency
for that year. Therefore, any error was harmless, and we
affirm the Tax Court’s ultimate deficiency determination.
III. CONCLUSION
For the reasons set forth above, the judgment of the Tax
Court is AFFIRMED.
RAWLINSON, Circuit Judge, concurring in part, and concur-
ring in the result:
I concur in the vast majority of the excellent opinion, and
I concur in the judgment. I write separately only because I do
not join that portion of the opinion holding that the Tax Court
erred in concluding that the 2003 fee payment did not consti-
tute interest.
The otherwise excellent opinion bases its conclusion
regarding the 2003 fee payment on assumptions rather than on
the record. See Opinion, p. 17626-27. However, we have
reviewed these determinations by the Tax Court for clear
error. See Gatto v. Comm’r, 1 F.3d 826, 828 (9th 1993) (“We
review for clear error the Tax Court’s determination that an
SAMUELI v. CIR 17629
interest deduction . . . was not the result of genuine indebted-
ness . . . .”) (citation omitted). The Samuelis’ claimed deduc-
tion resulted from a transaction that was similar to the one we
considered in Gatto—no money was actually exchanged
between the parties. See id. at 829 (noting that there was no
genuine indebtedness when a “loan” was really a promise to
pay money in the future). The assumptions made in the Opin-
ion do not establish clear error on the part of the Tax Court.
For that reason, I would affirm the Tax Court decision in its
entirety. Nevertheless, I concur in the judgment affirming the
Tax Court’s ruling.